If you know anything about me, it’s probably my profound love for time spreads, particularly long calendars. Long calendars consist of selling a call or put and buying another call or put with the same strike but a longer expiration. For me that usually means selling the current week’s expiration and buying the next if there are weekly options available. Positive theta is the main source of potential income for the position, but I like to look at it maybe a little differently. Let me explain.

Like a Vertical Credit Spread

I often compare long calendars to vertical credit spreads like bull puts and bear calls. But instead of buying a lower strike put for a bull put or a higher strike call for a bear call, an option trader buys a longer expiration option to protect the short option. The difference is for the long calendar you do not want the underlying to move too far away from the strike price. For a bull put spread as an example, it does not matter how high the underlying goes above the short put strike. The spread will profit.

Offsetting Delta

The biggest attribute I see that positive theta gives a long calendar is the means to offset adverse. If the underlying is around the short strike for a calendar, delta should be close to neutral. But as it goes higher or lower, positive or negative delta will surface. The more it moves away, the more significant delta becomes, and in steps positive theta. The positive theta from the short option has a larger theta than the long option with the negative theta. This positive theta can offset some positive or negative delta risk as the underlying moves higher or lower.

Of course, it only helps up to a point. As the underlying moves further away from the short strike, the positive theta also gets smaller. Theta is highest at-the-money (ATM) and it is also greatest between expirations when the underlying is ATM too. So, the positive theta edge will diminish when the underlying wanders too far away and limits its ability to offset delta.

Love Those Calendars

Long calendars cannot cure cancer or bring peace to the world. But what they can do for an option trader is pretty remarkable, and it all revolves around positive theta.

John Kmiecik, Market Taker Mentoring