Calendar spreads are an option trade that involves selling a short-term option and buying a longer-term option with the same strike.
Traders can use calls or puts and they can be set up to be neutral, bullish or bearish with neutral being the most common.
When doing bullish calendar spreads, we typically use calls to minimize the assignment risk. Likewise, if the calendar is set up with a bearish bias, we use puts.
Neutral calendars can use calls or puts, but calls are more common.
Let’s look at a couple of examples, using Nike (NKE), Apple (AAPL) and Goldman Sachs (GS)
NKE Neutral Calendar Spread
Let’s use NKE stock for our first calendar spread example.
With Nike stock trading around 105, setting up a calendar spread at 105 gives the trade a neutral outlook.
Selling the September 16 call option with a strike price of 105 will generate around $230 in premium, and buying the October 21, 105 call will cost approximately $555.
That results in a net cost for the trade of $325 per spread, and that is the most the trade can lose.
The estimated maximum profit is $200, but that could vary depending on changes in implied volatility.Â
The idea with the trade is that if NKE stock remains around 105 for the next few weeks, the sold option will decay faster than the bought option allowing the trade to be closed for a profit.
The breakeven prices for the trade are estimated at around 100 and 110, but these can also change slightly depending on changes in implied volatility.
In terms of trade management if NKE broke through either 100 or 110, I would look to adjust or close the trade.
Let’s look at another example.
AAPL Neutral Calendar Spread
With Apple stock trading around 155, setting up a calendar spread at 155 gives the trade a neutral outlook.
Selling the September 16 call option with a strike price of 155 will generate around $260 in premium, and buying the October 21, 155 call will cost approximately $560.
That results in a net cost for the trade of $405 per spread, and that is the most the trade can lose.
The estimated maximum profit is $300, but that could vary depending on changes in implied volatility.Â
The idea with the trade is that if AAPL stock remains around 155 for the next few weeks, the sold option will decay faster than the bought option allowing the trade to be closed for a profit.
The breakeven prices for the trade are estimated at around 148 and 163, but these can also change slightly depending on changes in implied volatility.
In terms of trade management if AAPL broke through either 148 or 163, I would look to adjust or close the trade.
Let’s look at our last example.
GS Neutral Calendar Spread
With Goldman Sachs stock trading around 335, setting up a calendar spread at 335 gives the trade a neutral outlook.
Selling the September 16 call option with a strike price of 335 will generate around $710 in premium, and buying the October 21, 355 call will cost approximately $1,520.
That results in a net cost for the trade of $810 per spread, and that is the most the trade can lose.
The estimated maximum profit is $550, but that could vary depending on changes in implied volatility.Â
The idea with the trade is that if GS stock remains around 355 for the next few weeks, the sold option will decay faster than the bought option allowing the trade to be closed for a profit.
The breakeven prices for the trade are estimated at around 323 and 349 but these can also change slightly depending on changes in implied volatility.
In terms of trade management if GS broke through either 223 or 349, I would look to adjust or close the trade.
Mitigating Risk
Thankfully, calendar spreads are risk defined trades, so they have some build in risk management. Position sizing is crucial to ensure that minimal damage is done if the trade suffers a full loss.
One way to set a stop loss for a calendar spread is close the trade if the loss is 20-30% of the premium paid.Â
Calendar spreads can also contain early assignment risk, so be mindful of that if the stock breaks through the short strike and it’s getting close to expiry.
Please remember that options are risky, and investors can lose 100% of their investment. This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
*Disclaimer: On the date of publication, Gavin McMaster did not have (either directly or indirectly) positions in some of the securities mentioned in this article. All information and data in this article is solely for informational purposes. Data as of after-hours, September 1, 2022.
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