What Is a Reverse Calendar Spread?
A reverse calendar spread is a type of unit trade that involves buying a short-term option and selling a long-term option on the same underlying security with the same strike price. It is the opposite of a conventional calendar spread. Reverse calendar spreads can also be known as reverse horizontal spreads or reverse time spreads.
- A reverse calendar spread is an options strategy to buy a short-term option while simultaneously selling a longer-term option in the same underlying with the same strike price.
- A reverse calendar spread is essentially a short position in a conventional calendar spread.
- A reverse calendar spread is most profitable when the underlying asset makes a significant move in either direction before the near-month option expires.
Understanding Reverse Calendar Spreads
Reverse calendar spreads and calendar spreads are a type of horizontal spread. Generally, spreads may be either horizontal, vertical, or diagonal. Most spreads are also constructed as a ratio spread with investments made in unequal proportions or ratios. A spread with a larger investment in long options will be known as a backspread while a spread with a larger investment in short options is known as a frontspread.
A reverse calendar spread is most profitable when markets make a huge move in either direction. It is not commonly used by individual investors trading stock or index options because of the margin requirements. It is more common among institutional investors.
As a horizontal spread strategy, the reverse calendar spread must use options on the same underlying asset with the same strike price. In all horizontal spreads, the goal will be to benefit from price changes over time. Therefore, horizontal spreads will use options with differing expirations.
A reverse calendar spread is known for taking a long position in the near-term option and a short position in the longer-term option. This differs from the calendar spread which takes a short position in the near-term option and a long position in the longer-term option.
Reverse calendar spreads can be constructed with either put or call options. Like their calendar spread counterpart, they must use either one or the other in both legs of the unit trade.
Using either put or call options, the strategy will usually be constructed as either a backspread or a frontspread. A backspread (long spread) will buy more than it sells and a frontspread (short spread) will sell more than it buys.
- Reverse calendar call spread: This strategy will focus on calls. As a reverse calendar spread it will buy calls in the near term and sell calls in the longer term. It seeks to benefit from falling prices.
- Reverse calendar put spread: This strategy will focus on puts. As a reverse calendar spread it will buy puts in the near term and sell puts with a longer-term expiration. It seeks to benefit from rising prices.
Reverse Calendar Spread Example
With Exxon Mobil (NYSE: XOM) stock trading at roughly $73.00 at the end of May 2019:
- Buy the June '19 75 call for $0.97 ($970 for one contract)
- Sell the September '19 75 call for $2.22 ($2,220 for one contract)
Net credit $1.25 ($1,250 for one spread)
Since this is a credit spread, the maximum loss is the amount paid for the strategy. The option bought is closer to expiration and therefore has a lower price than the option sold, yielding a net receipt of premium.
The ideal market move for profit would be a significant rise in the underlying asset price during the life of the near-term option followed by a period of stability to a gradual decline during the life of the far-term option. Initially, the strategy is bullish but after the shorter option expires it becomes a neutral to bearish strategy.