subject: Calendar Spread - The Option Traders Favorite [print this page] A cash flow option technique that is used by both professional traders as well as retail traders is the Calendar Spread. This technique is a favorite among option traders who use options as a way to generate reliable monthly cash-flow.
The calendar spread is a theta trade - an option trade that benefits and generates profit - from the fact that options are a decaying asset. As time goes by, options decay - and the value that was initially in the option that was sold evaporates - leaving cash in the calendar spread traders pocket.
To construct a calendar spread trade, we need to sell a closest month option while buying a later month option at the identical strike price. During the trade, the time premium in the closer month option (the one that was sold) loses it's value at a much brisker rate than the option that was bought. This difference is how the profit is generated.
Following is a made up example of a calendar spread place on SPY: Buy 1 Aug 105 call. Sell 1 Sept 105 call.
In the sample trade given, the trade was built using option strikes on conjoining months - however - this isn't necessary. Calendar spread trades can be created using options with varying lengths between them.
For example, rather than constructing a calendar spread using Aug and Sept month options, it could be created using a Aug month option and an Oct month option - or a Aug month option an a Nov month option.
Typically calendar spread traders will utilize this strategy when they believe the underlying vehicle they are trading will stay in a range - or will wind up on expiration day close to or right at strike price which was sold.
When you talk with some option traders, some will tell you they prefer the calendar spread strategy because they believe they are easier to manage than some of the other strategies like the iron condor, credit spread, or the butterfly spread. Regardless, the calendar spread is a great strategy to learn and have ready to use in your 'option trading toolbox'.
by: David Harms
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