How Does an Options Calendar Work?

The market continues to be volatile and many traders fail to consider how a time spread like a calendar spread can profit from a neutral or for that matter a directional outlook. A calendar spread, or what is sometimes referred to as a time spread, can be a pretty simple and straightforward option strategy. The spread is designed to work somewhat like a covered call but without the initial outlay of cash that can accompany buying shares of stock. The spread profits from time decay and can make money in any direction depending on the strikes that are chosen. Options are versatile.

Creating a calendar spread involves buying and selling options on the same underlying with the same strikes but different expirations. The best-case scenario is for the stock to finish at the strike price allowing the short-term option to expire worthless and still have the long option retain much of its value.

Let’s pretend ABC Inc. (ABC) was trading right around $183. This area coincides with a pivot level it has traded around in February and March. The trader forecasts that the stock might stick around that area for a few more days until Apr-12 expiration about seven days away. The option trader can buy the Apr-19 (14 days until expiration) 182.5 call for 4.30 and sell the Apr-12 182.5 call for 2.80. This trade is a debit spread and the maximum loss for this trade is $2.50 (4.30 – 2.80).
If the stock continues to trade around the $183 (or more specifically the $182.50) level, the spread's value would increase. The Apr-19 182.5 call might be worth 3.90 and the Apr-12 182.5 call might have dropped to 0.90 after four days have passed. The spread now would be 3.00 (3.90 – 0.90). A profit could now be made of $0.50 (3 – 2.50). That doesn’t sound like much but a $0.50 profit on a $2.50 investment in just four days is not a bad return in my opinion.
The whole key to the success of the calendar spread is the stock must not have huge price swings. If the stock falls more than anticipated, the spread's value will decline along with the stock. If the stock rises well above $182.50, the short Apr-12 182.5 call will partially or fully offset the increase in the long Apr-19 182.5 call depending on how much the stock rises.

There are other factors that can affect a calendar spread like implied volatility. This can be looked at another time. Remember, there are option strategies for every outlook; you just need to know what to look for and how to implement them.

John Kmiecik, Market Taker Mentoring

Trader Education