Lesson Overview

Call Calendar Spread

Long call calendar spreads profit from a slightly higher move up in the underlying stock in a given range. They also profit from a rise in implied volatility and are therefore a low-cost way of taking advantage of low implied volatility options.

Calendar spreads lose if the underlying moves too far in either direction. The maximum loss is the debit paid, up until the option you sold expires. After that, you are long an option and your further risk is the entire value of that option.

Options in nearer-month expirations have more time decay than later months (they have a higher theta). The calendar spread profits from this difference in decay rates. This trade is best used when implied volatility is low and when there is implied volatility "skew" between the months used, specifically when the near-month sold has a higher implied volatility than the later-month bought.

More Discussion

Was This Helpful? Add Comments/Questions

  • JC

    Hi Kirk, I don’t exactly understand how these 2 options would create this sort of shape – can you please elaborate?

    • It’s flexible and dynamic because it’s created from the difference in prices between the front month and back month + the fact that you bought one and sold another.

  • We have a 25% profit target on calendars so we would close a calendar we purchased fro $1.00 at $1.25

  • Steve

    Kirk,

    Can the weekly options be used for a calendar spread as long as the front and back months are actually different months? e.g. a weekly in May and the monthly in June?

  • IV for sure since we want to trade these mainly during low volatility markets.

  • Yes, you want to use call when you are a little bullish and puts when you are a little bearish.

  • Raymund Andales

    Hey Kirk thanks for all your videos, it’s greatly appreciated. Quick question though,
    I don’t quite understand how profit is made with this strategy. In a situation where
    the price goes back to 203.08 and implied volatility stays about the same by the time
    the front month contract gets close to expiration.

    4.96 debit – selling it a bit less because of THETA (PRICE AND IV STAYS THE SAME)
    3.98 credit – not getting full credit at closing if price does not close @ $205
    .98 total debit –

    BY the time when the trade is closed, some credit will be received by
    buying back the front month but it won’t be the full credit if the price
    does not get up to $205 and on the debit side I would think that the price would be
    lower because of THETA eating up at it and with IV staying at the same level. So, are
    we hoping to see the decay in the front month would be big enough than the decay in the
    back month to cover for the .98 debit and that would be the profit?

    • Correct we are betting on the decay being faster in the front month than the back month (all else being equal).

  • Right could be more past the front month expiration but we don’t ever suggest holding past the front month expiration.

  • Yes correct – you look to close before the front month expiration to avoid assignment if possible.

  • Each P&L chart will be different slightly because of the differential in pricing but it should still have the same general shape.

Show Video Transcript +

In today's video, we’re going to go over the specifics of trading a call calendar spread. A long call calendar spread profits from a slightly higher move up in the underlying stock inside of a given range, but they also profit from a rise in implied volatility and therefore, are a great low-cost way of taking advantage of low implied volatility markets and options.

We often trade these when implied volatility has dropped and sometimes, they’re really good in bullish markets. As stocks are slowly starting to rally higher, you want to trade either directionally spreads or trade some of these calendar spreads.

This is exactly how you setup this strategy. First, you're going to sell a front month out of the money call option. This is the key point here.

We’re going to sell that front month out of the money call option, that front month option is going to be a little bit closer to where the market is trading, so days out is probably anywhere between 20 and maybe 35 days out, then what you’re going to do is you’re going to buy a more expensive back month option, so the next monthly option that’s out, an out of the money call spread at the same strike price.

We’re going to be trading two different months, but pinning the same strike price. What's the risk? Your risk in these calendar spreads is limited to the width of the net debit paid for the spread. If you paid a debit of $150 for your calendar, your risk is limited to just that $150; you can’t lose any more money than that.

Let’s talk about profit potential. It can be very hard with these strategies because of the decay in the back month option that you’re long to pinpoint an exact probability of profit. Ideally, what you’re looking for though is to target your profit at the value of the sold front month contract.

If you sold the front month contract for $50 and you bought the back month contract for $150, you’re looking to profit somewhere around $50 or that decay in the value of that front month contract.

Profit is going to be maximized if the stock settles at the strike price at expiration because if that happens, then your short strike is completely going to expire worthlessly and you’re going to be left with as much extrinsic value left in the long option for the back month as possible. That’s the ideal situation. That's where this profit and loss diagram peaks, is right at your strike prices.

Volatility like we said, an increase in volatility will help this position because we’re going to be net long options, we’re going to have a longer term option in the back month and compare to the negative impact on the front month option we’re short, we’re going to see a greater impact in volatility on the value of that back month option.

That’s why volatility is really good for these positions. That’s also why you want to trade them first when implied volatility is low because if you trade these positions when implied volatility is high, you’re putting yourself at a disadvantage right off the bat because an increase in volatility is going to help and if implied volatility is already high, then you’re really stacking the deck against yourself.

Time decay is going to help this position because we’re looking to collect the value of that front month option that we sold. As an option seller, we like to see time decay and Theta decay start to slowly eat away or erode that position much faster. The closer we get to expiration, the faster that profit will start to materialize.

With calendars, breakeven points are so hard to calculate because there’s no single calculation we can use. It’s just important that you analyze the trade first before placing an order.

We will analyze a trade right here on our Thinkorswim platform. For this video tutorial, what we’re going to do is we’re going to use the SPY which is the S&P 500 ETF. It’s currently trading at just over 23, and we’re going to do a calendar between March and April.

In this case, the March options which have about 58 days to go here (and we’ll just going to use a calendar that’s a little bit further out) and those are going to be our front month contracts.

In most cases, we might look to do something a little bit closer, but for this video, I wanted to do something that has really good profit and loss diagram.

The back month contracts, in this case, are going to be the April contracts which are about 86 days out. You can see the front month are March and the back month are going to be April. In this case, what we want to do is we want to start by selecting a strike price that’s just a couple of strikes out of the money.

In this case, we’ll go with the 205 strikes in both months, so we're going to target the 205 calls in both months. What we’re going to do is we’re going to first sell that front month contract.

We’re going to go up here to the option chain and just click on the bid to sell that front month option at 205. At the same time, what we’re going to do is also buy the 205 call for April.

Now down below, that creates our calendar spread and you can see here below this is our calendar spread, the April/March calendar and the difference between buying the back month and selling the front month which is these two prices right here is our net debit that we pay on this trade of about $.97 or $97. In this case, the most that we can lose on this trade is $97.

When we look at the profit and loss diagram, you can see that it's got the very familiar shape that we had in the video and the slides before. It’s got that high peak that rallies up to 205, and that's the point at which we make most of our money and then from there, it starts to slowly decline on either end.

But the key here is you don't lose any more than $97 regardless of where the stock goes. But this profit window for this calendar that we created is very large. In this case, we can make money all the way from 198 all the way up to about 212 on SPY.

SPY is currently trading about 203, so we’re playing this a little bit directionally bullish, that’s why we’re doing the call calendar, we ideally like to see the stock rally a little bit, but in this case, we also leave ourselves an opportunity to make some money even if the stock drops in value.

That’s why these are slightly directional trades, but if you set them up correctly, you end up giving yourself an opportunity to make money in both directions of where the stock might move in the future.

Some of the key takeaways for calendar spreads are that they’re low implied volatility strategies. They work best in markets that are low implied volatility that could see a rise in implied volatility and use these strategies one to two levels out of the money with your strike prices in the direction that you want to trade.

In the example we just went through with SPY, the stock was trading at about 203, and we traded the 205s, so we were just about two strike prices out.

You don’t want to get any further than that, and you’re going to play it very, very directionally and not going to take advantage of what a calendar really can do. We always suggest closing the spread completely both months when you reach that front month expiration whenever possible.

The reason that you’re going to do that is that you want to maximize that time decay in the front month contract. Going back to the spread that we had traded in SPY because we sold this option for about 3.95, that's ideally the most that we would ever look to make this trade, but in our case, we might look to take maybe about a doubling in our premium as far as a profit.

If we could increase our premium 100%, we would take that as far as a profit. As always, I hope you guys enjoy these videos. If you have any comments or questions, please ask them right below on the lesson page. Until next time, happy trading!

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