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Dissecting the Calendar Spread Strategy

By Jeff Neal, Optionetics.com | Mon October 29, 2007 1:45PM PT


One of the more flexible spread strategies that provide a nice risk-to-reward profile is the calendar spread position. Even though the options strategist needs to show patience to let profits develop, its overall consistency of being correct and its inherent adjustment capabilities make it a very useful strategy to understand.

First it is important to understand exactly how a calendar strategy is put together. Constructing the calendar spread consist of selling a short-term option and purchasing a long-term option, typically using at-the-money options with all calls or all puts. Calls can be used for a more bullish bias and puts can be used for a more bearish bias. The calendar strategy involves the buying and selling of an equal number of calls or puts with the same underlying security with the same strike price and using different expiration dates.

What is unique about a time-based strategy like the calendar is that the risk, reward, and breakeven points are not set in stone. For example, the strategy has limited risk tied to the net debit paid to open the position. However, the options strategist can choose to roll out this strategy to the next month, which will lower the risk because the trader will be taking in additional credit for replaying this strategy.

In addition, the reward might be limited but the exact maximum potential varies based on several factors including volatility, expiration months and stock price. Given that a calendar spread is a bit more of a complex trade it is highly recommended that the trader use a good options analysis tool like the Platinum site at Optionetics.com to determine the breakeven points. 

For an options strategist to be consistently successful when implementing the calendar strategy, some key rules need to be adhered to. First, the trader needs to identify a market that has been range trading for at least 2 to 3 months and is anticipated to remain within a range going forward. Next, explore implied volatility and make sure it is relatively low.

Once potential stocks candidates have been selected, the trader needs to create a risk profile that looks the most attractive and at the same time is practical. The strategist must also have a clear exit plan in place before opening a calendar spread position. If the stock keeps the short option out-of-the-money, the option strategist can hold to keep the full credit. If the stock moves the short option in-the-money, the trader can either exit the trade for a loss or buy back the short option prior to expiration and roll out the short option to the next month.

Usually calendar spread traders will exit the position if at anytime they experience a 50 percent loss or when the long option has 30 days or less until expiration. The beauty of the calendar spread is that when the underlying still remains in a trading range, the option strategist can roll out each month continuing to lower risk until the point they have a guaranteed profit and dramatically boosting their final Return on Investment performance.

The calendar spread is a great strategy to learn because it is easy to adjust as market conditions change and, though it may be slow moving, as time decays rapidly in the front month, the profits from this strategy will surely accrue. Of course, paper trade it first to understand its flexibility and all the possibilities associated with it, and then by all means add it to your trading arsenal.  


Jeff Neal 
Senior Writer, Options Strategist & Profit Strategies Radio Show Market Correspondent
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Recent articles by Jeff Neal, Optionetics.com


July 22, 2010  -  Morning Watch, July 22
December 29, 2009  -  Dissecting the Basic Stock Quote Page
December 29, 2009  -  Back to Basics: Reviewing the Market Entry and Exit Orders
June 12, 2009  -  Interview Central: Mark Seleznov, Part III
June 05, 2009  -  Interview Central: Mark Seleznov, Part II


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