A calendar spread is a trade on time itself. You sell a short-dated option and buy a longer-dated one at the same strike. The short one loses value faster, and the difference in how quickly they decay is where the profit comes from. It works best when the stock sits near the strike until the near-term option expires.
How it’s built
Two options of the same type (both calls or both puts) at the same strike:
- Sell a near-term option, say one month out.
- Buy a longer-term option, say three months out.
The longer option costs more, so you pay a net debit. Time decay speeds up as expiration gets closer, so the short option should lose value faster than the long one, and the spread widens in your favor.
Max profit, max loss and break-even
| Calendar spread | |
|---|---|
| Max profit | Reached if the stock is right at the strike when the short option expires. It depends on how much time value the long option still has then, so there’s no simple formula. |
| Max loss | The net debit |
| Break-evens | Below and above the strike. They depend on implied volatility, so use a calculator or your broker’s risk graph. |
Worked example
Apple ($AAPL) is at $150, and you expect it to stay around there for the next month. You sell the one-month $150 call for $3 and buy the three-month $150 call for $6. Net cost: $3 a share, or $300.
- AAPL is at $150 when the short call expires: the short call expires worthless. The long call still has two months left, so it keeps much of its value. This is the best case, and you can either sell the long call for a profit or sell another one-month call against it.
- AAPL rallies hard, to $170: both calls are deep in the money and trade close to the same price, so the spread shrinks toward zero. You lose most of the $300.
- AAPL drops to $135: the short call expires worthless, but the long call has lost much of its value too. You lose much of the $300.
That’s the shape of a calendar: it wins when the stock stays put, and loses when it moves a lot in either direction. Your loss can never exceed the debit.
When it makes sense
- You expect the stock to stay near a price for the next few weeks.
- Near-term implied volatility is high relative to longer-dated options, which makes the option you’re selling expensive.
- You want a defined-risk way to sell time decay without selling naked options.
What to watch out for
- Big moves either way. The further the stock gets from the strike, the less the spread is worth.
- Volatility changes. A drop in implied volatility hurts the long option more than the short one, because longer-dated options are more sensitive to it.
- Two expirations. You need a plan for what to do when the short option expires: close everything, or sell another short-term option.
Tips
- Put the strike where you think the stock will be when the short option expires.
- Avoid earnings between the two expirations unless that’s deliberately part of the trade.
- Take profits near the short expiration. That’s when the spread is usually worth the most.
If you have a directional view as well, the diagonal spread uses different strikes to add one.