What Are Calendar Spreads and How Do They Work?
Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.
Many options spread strategies consist of buying and selling call or put options that expire at the same time. Calendar spreads, on the other hand, involve buying and selling call or put options on the same underlying asset with different expiration dates. A calendar spread typically includes selling a near-dated option and buying a longer-dated (or longer maturity) option with the same strike price.
Rather than seeking favorable directional movement in the underlying stock, the calendar spread takes advantage of implied volatility and the way that it typically changes over time.
Like other option spread strategies, a calendar spread limits a trader’s potential losses, but it also caps their potential return. Calendar spreads are considered an advanced option trading strategy, so it’s important to have a handle on how they work and the potential risks.
Key Points
• Calendar spreads attempt to capitalize on implied volatility changes over time.
• After the near-term option expires, shifts in implied volatility can significantly impact the profitability of the remaining long-dated position.
• A rise in implied volatility benefits the long-dated option position.
• Implied volatility changes can affect the breakeven calculation.
• A calendar spread involves selling a near-term option and buying a longer-term option with the same strike price but different expiration dates.
Calendar Spreads Defined
A calendar spread, also known as a horizontal spread, is an options trading strategy that is created by simultaneously taking a long and short position on the same underlying asset and strike price, but with different expiration dates. Calendar spreads can consist of either calls or puts. Typically, the long-dated option is purchased (the long leg), and the nearer-dated option is sold (the short leg).
How Calendar Spreads Work
Calendar spreads are typically established for a net debit, meaning you pay at the outset of the trade. Generally speaking, a longer-dated option will be more expensive than a shorter-dated one if the strike prices are the same, given there is more time for the underlying asset’s value to move up or down. This reflects the effect of time decay, which is the decline in an option contract’s value as it approaches its expiration date.
Time decay is essential to how calendar spreads work. It tends to accelerate as an option’s expiration approaches, meaning the value of the near-dated short option in a calendar spread could lose value more quickly than the long option that has more time until expiration.
A calendar spread is best positioned for profitability when the stock price remains near the options’ strike price at the time of the short-term expiration date, as the short option will have declined in value or expired out of the money, while the long option retains potential gains. Calendar spreads function fairly similarly whether constructed with calls or puts. Depending on where the stock price is relative to the strike price selected at the outset of the trade, and whether calls or puts are used, a calendar spread can be neutral, slightly bearish, or slightly bullish.
Maximum Profit on Calendar Spread
A calendar spread strategy reaches its maximum profit when the stock price settles at the near-term strike price by that option’s expiration, which applies to the common approach of selling a near-term option and buying a longer-term option. This is not the end of the trade, however. The trader may also benefit if stock price rises after the near-dated option’s expiration, since they still have a long position with the later-date call option.
A rise in implied volatility after the short-term option expires can also benefit the longer-term option position. Some traders might choose to close the long option position when the near-dated option expires.
Maximum Loss on Calendar Spread
A calendar spread is typically considered a debit spread since the cost of the later-dated option is greater than the potential proceeds from the near-date option’s sale. Thus, the trader can not lose more than the premium paid.
Break-even Point
The precise break-even calculation on a calendar spread option trade cannot be determined due to the two different option delivery dates. Changing option Greeks – such as implied volatility levels and market interest rates — complicate the calculation of an exact break-even price.
Traders must estimate what the value of the long-dated option contract will be on the near-dated option’s expiry. One way to do this is by using an online option strategy profit and loss calculator to estimate a break-even price.
Calendar Spread Example
Suppose a trader holds a stock that they believe will not change much in value during the next month. The trader sells a call option expiring in one month, and buys a call at the same price that expires in two months at a slightly higher premium, which is more expensive because it has more time value than the near-dated call.
During the next month, the stock fluctuates after the trade was executed, but settles back to its strike price by the afternoon of the short-term option’s delivery date. Since time has passed and the stock has not drifted from its original value, the near-dated short call option has lost considerable time value, and may expire worthless. The later-dated call is now worth slightly more.
Calendar Spread Payoff Diagram
Calendar Spread Risks
There are several risks that traders must keep in mind when using calendar spreads.
Limited Upside
The risk and profit potential of a calendar spread depend on whether the strategy is a long or short calendar spread.
A long calendar spread, where the trader buys a longer-dated option and sells a near-term option, has a capped profit potential if the trade is closed at the expiration of the near-dated option. Option traders benefit from time decay in this case, as well as increases in implied volatility. When the short option expires or is brought to a close, there is unlimited upside with the remaining long call, assuming it is held beyond the near-term option’s expiration date.
A short calendar spread, where the trader buys a near-term option and sells a longer-dated option, has theoretically unlimited risk if the underlying stock moves significantly. Because the short position is in the longer-dated option, potential losses can exceed the initial premium collected.
If the trader uses puts, the risk dynamics remain similar, but the profit potential and exposure depend on whether the put calendar spread is long or short.
Delivery Dates
Traders must make a choice when the near-dated option is close to expiring. The trader can let it expire if the position is out of the money. If it is in-the-money, it might be worthwhile for the trader to buy and close the option or consider the potential impact on the remaining position.
Timing the Trade
Being correct about the near-term direction of the stock, as well as changes in implied volatility and time decay, can be challenging. Successfully timing the trade requires accurate predictions of both short-term price movements and also changes in volatility, which can be unpredictable and carry inherent risk.
Types of Calendar Spreads
There are several types of calendar spreads. Here’s a look at some of the most popular strategies.
Put Calendar Spread
A calendar put spread option is a strategy in which a trader sells a near-dated put and buys a longer-dated put. A trader would put this trade on when they are neutral to bearish on the price change of the underlying stock in the near-term. Once again, this type of calendar spread options strategy aims to benefit from time decay or higher implied volatility.
Call Calendar Spread
A calendar call spread involves shorting a near-term call and buying a longer-dated call at the same strike. (This is the strategy outlined in the earlier example.) The near-term outlook on the underlying stock is neutral to slightly bearish while the trader might have a longer-term bullish view.
Diagonal Calendar Spread
A diagonal calendar spread uses different strike prices for the two options positions. This strategy still uses two options — either two calls or two puts — with different expiration dates. This strategy can be either bullish or bearish depending on how the trade is constructed. The term diagonal spread simply refers to the use of both a calendar spread (horizontal) and a vertical spread.
Short Calendar Spread
Traders can use a short calendar spread with either calls or puts. It is considered a “short” calendar spread options strategy because the trader buys the near-dated option while selling the longer-dated option. This is the opposite of a long calendar spread. A short calendar spread profits from a large move in the underlying stock, but carries the risk of substantial loss if volatility increases. However, because both legs are options, a long calendar spread has a limited maximum loss, while a short call calendar spread carries theoretically unlimited risk.
The Bottom Line
Calendar spreads are useful for options traders who want to profit from changes in stock variables other than price direction. They’re an advanced strategy, however, that may not make sense for beginner investors.
Investors who are ready to try their hand at options trading despite the risks involved, might consider checking out SoFi’s options trading platform offered through SoFi Securities, LLC. The platform’s user-friendly design allows investors to buy put and call options through the mobile app or web platform, and get important metrics like breakeven percentage, maximum profit/loss, and more with the click of a button.
Plus, SoFi offers educational resources — including a step-by-step in-app guide — to help you learn more about options trading. Trading options involves high-risk strategies, and should be undertaken by experienced investors. Currently, investors can not sell options on SoFi Active Invest®.
FAQ
Is a calendar spread bullish or bearish?
Calendar spreads can be neutral, slightly bullish, or slightly bearish depending on the trader’s outlook. An options trader may construct the spread using puts or calls and a specific strike price that aligns with their view of market conditions.This depends on the way the spread is set up as well as the trader’s outlook. The primary objective is to benefit from changes in time decay and implied volatility changes, rather than a significant price move in the underlying asset.
Are calendar spreads good to use?
Calendar spreads can be a useful strategy for traders who are trying to benefit from volatility or time decay, rather than directional price movement. As with any options strategy, they come with risks, including the potential for limited profits and the complexity of managing both the short- and long-dated positions. Calendar spreads are generally considered an advanced strategy, so they may not be suitable for all investors.
Should you let a calendar spread expire?
Whether to let a calendar spread expire depends on the position of the trade as it nears expiration. If the short-term option expires out of the money, the trader may allow it to expire and keep the longer-term option open. However, if the short-term option expires in the money, it might be worth closing both positions or rolling the trade to adjust the strategy. The decision should align with the trader’s market outlook and risk tolerance.
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Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
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