What is a Horizontal Spread

A horizontal spread is an options or futures strategy created with simultaneous long and short positions in the derivative on the same underlying asset, and for options, the same strike price, but with different expiration months. The goal is to profit from changes in volatility over time or exploit perceived temporary aberrations in pricing due to short-term events.

Also called a calendar spread, time spread, inter-delivery spread or intra-market spread.

BREAKING DOWN Horizontal Spread

While horizontal spreads, and their more common name calendar spreads, are widely used in the futures market, much of the analysis is focused on the options market where volatility changes are crucial to pricing. The following considers long spreads that seek to profit from increases in volatility over time. Short spreads are created in the opposite configuration and seek to profit from decreases in volatility.

Since the goal for a long spread is to profit from time and volatility, the strike price should be as near as possible to the underlying asset's price. The trade takes advantage of how near- and long-dated options act when time and volatility change. An increase in implied volatility, all other things held the same, would have a positive impact on this strategy because longer-term options are more sensitive to changes in volatility (higher vega). The caveat is that the two options can and probably will trade at different implied volatilities.

The passage of time, all other things held the same, would have a positive impact on this strategy in the beginning of the trade until the short-term option expires. After that, the strategy is only a long call whose value erodes as time elapses. In general, an option's rate of time decay (theta) increases as its expiration draws nearer.

The typical options trade comprises the sale of an option (call or put) with a near-term expiration date, and the simultaneous purchase of an option (call or put) with a longer-term expiration. Both options are of the same type and use the same strike price.

  • Sell near-term put/call
  • Buy longer-term put/call
  • Preferable but not required that implied volatility is low

Again, a short horizontal spread would be the opposite with a long near-term option and a short longer-term option. Preferable but not required that implied volatility be higher.

Example of a Calendar Spread

With Exxon Mobil stock trading at $89.05 in mid-January, 2018:

  • Sell the February 89 call for $0.97 ($970 for one contract)
  • Buy the March 89 call for $2.22 ($2,220 for one contract)

Net cost (debit) $1.25 ($1,250 for one contract)

Since this is a debit spread, the maximum loss is the amount paid for the strategy. The option sold is closer to expiration and therefore has a lower price than the option bought, yielding a net debit or cost. The short horizontal spread is a credit spread, meaning the trader receives money at the start of the trade.

The ideal market move for profit would be a steady to slightly declining underlying asset price during the life of the near-term option followed by a strong move higher during the life of the far-term option, or a sharp move upward in implied volatility.

Initially, the strategy is market neutral or slightly bearish but after the shorter option expires it becomes a bullish strategy.