The purpose of a calendar spread is to profit from the passage of time. By reading this article, investors will gain a basic understanding of the different types of calendar spreads so that they are able to use those spreads in their own investing playbook.
A calendar spread is typically composed of selling an option with a near-term expiration date and buying an option with a longer-term expiration date. Calendar spreads can be made up with either call options or put options.
The maximum loss that could occur is the amount paid for the strategy. The option that is sold is cheaper than the option that is bought because the sold option is closer to expiration than the bought option. The longer an option has until expiration, then the more expensive it is.
One of the most commonly used calendar spreads is the call calendar spread. The call calendar spread involves buying a longer-term call option while simultaneously selling a nearer-term call option that is “at-the-money” or just slightly “out-of-the-money.” Both options have the same strike price.
When using the call calendar spread, the ideal scenario would be if the underlying stock’s price declined slightly during the span of the near-term option, then rose sharply during the span of the far-term option.
If this happened, the sold call option would expire worthless and the bought call option would enter a long call position, which has no upper limit on its profit potential. In the ideal scenario when using the call calendar spread, the investor reduces his cost on purchasing a longer-term call option.
After this brief description of a call calendar spread, investors should feel more confident to add this strategy to their investing playbook. There is more advanced calendar spread strategies besides the call calendar spread. Investors should do further research into those strategies to see how those could be useful as well.