Options are known for their versatility. In addition to the purchase or sale of a single option, the combination of different option contracts with different strike prices and/or expiration dates creates a variety of Option strategies. Among the most frequently used strategies with more than one option are vertical spreads. Here, options with the same expiration date and different strike prices are combined. A calendar spread, on the other hand, combines options with the same strike price but different expiration dates. How exactly a calendar spread works and when its use can be useful, you will learn in this article.
Definition Calendar Spread
With a calendar spread, a Call- or Put option with a longer term is bought and at the same time an option with a shorter term is sold at the same strike price.
P&L diagram of a calendar spread
As can be seen in the P&L diagram of the calendar spread, the trade makes a profit if the underlying moves as little as possible.
What to pay attention to when trading a calendar spread
A calendar spread is suitable for speculating on a sideways movement of a market. The trade is set up with a debit, i.e. you first pay an Option premium. The bottom line of the strategy is that it profits from the time value loss of the options. In contrast to option strategies such as a Short Strangle, Short Straddle or Iron CondorThe calendar spread is benefiting from an increasing implied volatility.
Maximum loss
The maximum possible loss of a calendar spread is limited to the amount of the option premium paid. This occurs when the underlying moves very far in one direction and the difference between the two option prices thus approaches zero.
Maximum profit
The maximum profit of a calendar spread cannot be calculated exactly due to the different expiration dates of the two options. The largest possible profit occurs when the underlying is quoted at the money (or slightly out of the money) on the expiration date of the option with the shorter remaining term. Thus, the sold option expires worthless and the purchased option can be sold again.
Market assessment
A calendar spread profits from a sideways movement of the market and should therefore only be used if you assume that the underlying will not make a large movement. Since there are other option strategies that benefit from a sideways market, it is also important that you analyze the implied volatility and have an assessment of this.
Implied volatility
Since the vega of the bought option with the longer remaining term is higher than the vega of the sold option with the shorter remaining term, a calendar spread is a strategy with a positive vega. This means the trade benefits from an increase in implied volatility and is therefore one of the few Option strategieswhich can benefit simultaneously from a decline in time value and an increase in volatility.