Calendar Spreads

A calendar spread, also called a time spread or horizontal spread, sells an option with a near expiration and buys an option of the same type and strike with a later expiration. Because near term options lose time value faster than longer term ones, the spread can profit if the underlying stays near the strike while the short option decays. Calendars also gain if implied volatility rises in the longer dated option. They are a staple for traders who expect a quiet market in the short term. Futures traders use "calendar spread" for a different trade between contract months, covered in Calendar Spreads in Futures.

Construction#

1. Sell a near term option (for example 30 days to expiry).
2. Buy a longer term option (for example 60 days) at the same strike.
3. Both calls or both puts.
4. Pay a net debit, since the longer option costs more.

How it makes money#

Calendars are long vega and, near the strike, positive theta. That combination is unusual: most positive theta trades are short vega. See Theta and Vega.

Worked example#

These figures use the at the money approximation 0.4 × price × volatility × √(time in years). Real prices also depend on skew and rates.

The payoff shape#

At the front expiration, a calendar's profit and loss looks like a tent centred on the strike: highest when price is at the strike, falling off on either side. The width of the tent depends on implied volatility of the remaining long option. Because the long option still has time value, the exact payoff depends on implied volatility at that time.

Term structure matters#

Calendar spreads are sensitive to the shape of the volatility term structure. See Volatility Term Structure.

• Front month volatility higher than back month (common before earnings or in stress): selling the expensive front option and buying the cheaper back option can be attractive.
• After an event, front month implied volatility often drops sharply, which helps calendars that sold the event expiry.

Choosing strikes#

• At the money for a neutral view.
• Slightly out of the money calls for a mildly bullish view, or puts for a mildly bearish view, so the profit peak sits at your target.

Managing a calendar#

• Close before the front expiry to avoid assignment and pin risk.
• Take profits when the spread has gained a good share of its expected value.
• Exit if price moves well away from the strike.
• Roll the short option to the next expiry to repeat the trade, turning it into a series of short options against one long option.

Risks#

• Large moves in either direction.
• Falling implied volatility in the back month.
• Early assignment of the short option, especially in the money before dividends. See Exercise and Assignment.
• Liquidity in the back month may be thinner.

Frequently asked questions#

What is a calendar spread in options?#

Selling a near term option and buying a longer term option at the same strike, profiting from faster decay of the short option and from rising implied volatility.

When is a calendar spread most profitable?#

When the underlying is near the strike at the front expiration and implied volatility in the long option holds steady or rises.

What is the risk of a calendar spread?#

A large move away from the strike or a drop in implied volatility can cause the spread to lose most of the debit paid.

Next, add different strikes to the mix in Diagonal Spreads.