Calendar spreads, also known as a horizontal spread or a time spread, is a type of options strategy that involves buying a long option with a near-term expiration date and selling a short option with the same strike price but a later expiration date. The goal of the strategy is to profit from a difference in the time decay of the two options. The trade is usually done with options of the same underlying security.
How to enter a calendar spread?
To enter a calendar spread, you first need to have a brokerage account that allows you to trade options. Here are the general steps to enter a calendar spread:
- Choose the underlying security that you want to trade. This could be a stock, an index, or a commodity.
- Select the strike price and expiration date for the option you want to buy. The strike price is the price at which the option gives you the right to buy or sell the underlying security, and the expiration date is the date on which the option expires.
- Buy the long option with the near-term expiration date. This is the option that you will hold until expiration.
- Select the expiration date for the option you want to sell. This should be later than the expiration date of the option you just bought.
- Sell the short option with the later expiration date. This is the option that you will sell in order to offset the cost of the option you bought.
- Monitor the trade and make adjustments as needed. As the expiration date of the options approaches, the time decay of the options will cause their prices to change. If the trade goes in your favor, you can close the position and take profit. If the trade goes against you, you can adjust the position or close it to limit your losses.
- It’s important to note that calendar spread strategy is a advanced strategy and one should have good understanding of options and market conditions before doing this. It would be advisable to consult with a financial advisor before entering into any options strategy.
What is the best scenario for a calendar spread?
The best scenario for a calendar spread is when the price of the underlying security remains relatively stable or moves in a limited range. In this case, the option with the near-term expiration date will experience more time decay than the option with the later expiration date. This will cause the value of the option you bought to decrease at a faster rate than the value of the option you sold, resulting in a profit for the calendar spread.
Another good scenario for a calendar spread is when the implied volatility of the options is high. Implied volatility is a measure of the expected volatility of the underlying security, and it affects the price of options. When implied volatility is high, options will be more expensive, which can increase the potential profit of a calendar spread.
It’s worth noting that the best scenario for a calendar spread can also be different based on the strike price of the options, if the spread is done with different strike price, the best scenario will be when the underlying security moves towards the strike price of the option that is sold.
In general, calendar spread strategy can be used for different market conditions and different outlooks like bullish, bearish or neutral. It’s important to have a good understanding of market conditions and consult with a financial advisor before entering into any options strategy.
Calendar Spread Adjustments
- Roll the Short Option: If the short option in your calendar spread is threatened by an imminent price move, you can roll it forward to a later expiration date. This involves closing out the existing short option position and opening a new short position with a later expiration date. By extending the time horizon, you give the trade more room to reach your target.
- Adjust the Strike Price: If the stock price has moved significantly and is approaching or surpassing the strike price of the short option, you can consider adjusting the strike price. This can be done by either rolling the short option to a higher strike price if the stock price is rising, or rolling it to a lower strike price if the stock price is falling. Adjusting the strike price allows you to potentially collect more premium and provide additional buffer room.
- Add or Remove Contracts: Depending on the market conditions and your outlook, you can adjust the number of contracts in your calendar spread. If you’re more bullish, you may add more contracts by opening additional long options. Conversely, if you’re more bearish, you may consider removing contracts by closing out some of your long positions. Adjusting the number of contracts can impact the risk-reward profile of the spread.
- Take Profits or Cut Losses: If the calendar spread has reached your profit target or if the trade is not performing as expected, you can choose to close out the position and take profits or cut losses. This calendar spread adjustment may involve closing both the long and short options simultaneously. By closing the position, you lock in any gains or limit potential losses.
- Monitor and Adjust as Expiration Approaches: As expiration approaches, monitor the position closely. If the stock price is near the strike price of the short option and there’s limited time remaining, it may be prudent to close out the position to avoid potential assignment or significant loss.
- Consider Volatility Changes: Calendar spreads are influenced by changes in implied volatility. If there’s a significant change in volatility, it can impact the value of the options in the spread. Monitor volatility levels and adjust your position accordingly. If volatility increases, it may present an opportunity to enter new calendar spreads.
When adjusting calendar spreads, it’s important to consider the potential impact on risk, cost, and profit potential. Each adjustment strategy carries its own set of risks and rewards, so it’s essential to evaluate the market conditions and your trading goals before implementing any adjustments. Additionally, it’s advisable to consult with a qualified financial professional or advisor who can provide personalized guidance based on your specific circumstances.
How to fix a calendar spread?
- Rolling the spread: If the underlying security is moving in an unexpected direction, you can “roll” the spread by closing the near-term option and opening a new option with a later expiration date. This can help you stay in the trade while adjusting for the new market conditions.
- Adjusting the strike price: You can adjust the strike price of the options to reduce the potential loss of the trade. This can be done by buying or selling options with a different strike price to offset the loss on the original options.
- Closing the spread: If the trade is not going in your favor and you want to minimize your losses, you can close the spread by buying back the short option and selling the long option. This will close the position and you will have to take the loss.
- Take profits: If the trade is going in your favor and you want to lock in the profits, you can close the spread by buying back the short option and selling the long option. This will close the position and you will have to take the profit.
- It’s important to note that fixing a calendar spread can be a complex process and it’s advisable to consult with a financial advisor before taking any actions. It’s also important to have a plan in place before entering into any trade and to have a good understanding of market conditions.