A Calendar spread is basically a features or options strategy. It is where an investor simultaneously enters the short and long positions on the same underlying asset but with different delivery dates. In a general calendar spread, you would purchase a long-term contract and go short with the nearer-term option with a strike price that is the same.
If there is a case where two distinct strike prices are utilised for each month, it is known as the diagonal spread. Usually, the calendar spreads are also called inter-delivery spreads. Here’s a quick look at everything you need to know about Calendar spread.
A Calendar spread typically involves purchasing and selling the identical kind of option for the same underlying security at the identical strike price but at distinct expiration dates. This sort of strategy is also known as the time or horizontal spread because of distinct maturing dates.
A general long calendar spread typically includes purchasing a longer-term option and selling a shorter-term option and of the same kind and exercise price. For instance, you might go ahead and purchase a couple-month 100-strike price call and sell a one-month 100-strike price call. This is generally a debit position; it implies that you are ahead and pay at the outset of the trade.
Basically, the primary difference lies between the primary position taken and the calendar spread options involved. A long calendar spread is typically done to capitalise on the relative time decay of options with various expirations in an environment of low volatility with minimal risk. By contrast, a short calendar spread basically aims to reap the advantages of high volatility in the near term. However, it carries a higher risk as the potential of massive losses if the market moves sharply.
The calendar spread options strategy allows traders to make a profit from sideways markets. There are generally two ways to make money from a calendar spread.
1.Get it from time decay.
2. Increase in implied volatility
The time gap basically says that short-term stocks will lose their value more quickly than long-term ones, giving traders the option to gain a profit from the price difference. However, as the market tends to move upwards, the odds of loss increase as well.
The second way to gain profit from a long-term calendar spread is from a rise in volatility in long-term options or a decrease in volatility in short-term options. Profit will keep on increasing with the rise in volatility in the long-term option.Also read about Option Hedging Strategies
Take any calendar spread options example that was successful; you will see a well-planned strategy behind it. Here are some of the ways you can utilise this calendar spread to maximise profit:
1. The calendar spread options strategy is generally applied to any financial instrument with a liquidity quotient. It can be anything like stocks or an ETF, for which there are few differences between the asking prices and bids.
2. Consider going with the covered calls.
3. Traders may go ahead and enter the spread when the market is neutral over a short span. They may utilise this legging strategy to slide over the price dips in the stocks that look like they are moving upwards.
4. Traders must try to minimise losses by considering the factors associated with limited uptrends in the early stages and different expiration dates.
5. Selecting the correct entry time is vital for the traders to gain from the deal.
6. Always look at the profit-loss (PL graph) graph before making a trading move.
7. Establish an upper limit and plan for an exit when you reach that limit.
It is a good idea to look up ex-dividend dates because it is crucial to comprehend assignment risk, particularly with regard to call spreads. The spread can be adjusted as needed to keep the long position in place, and as you go, you can also change the short contract's strike price to increase your delta exposure.
You will have to decide whether to sell another front-month contract, close the entire strategy, or let the long-term call or put to expire on its own when the short-term expiration date draws near.
Speaking of calendar spread, one thing that is more of a pro tip is that there are often major earning announcements. Do not get swayed by it easily. These are generally highly speculative deals that you need to look out for.
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