Calendar spread stock option trading strategy

What is a calendar spread?

The Calendar spread, stock option trading strategy, might be considered by a trader who is either bearish, neutral or bullish regarding their expectations of the movement of underlying stock.

The calendar spread is also referred to as a time spread or a horizontal spread because of the way the strategy is designed.

The strategy can be implemented with either calls or puts and consists of the purchase and sale of two option contracts, both with the same strike price and seperate expiration dates.

note- If different strike prices were used, the option strategy can then be referred to as a vertical spread.

Typically the calendar time spread is set up by the purchase of a further term option contract and the sale of a nearer term option contract.

The Time spread is a fascinating option strategy for several reasons. First off, the strategy is designed to capitalize off of the fact that shorter term options are more expensive then longer term stock options. As expiration nears, the short option looses value at a more accelerated pace then the longer term stock option contract. (refer to the page on the option greek "theta" for more information regarding the time decay of stock option contracts). If you have ever heard the expression "if your short, go short and if your long, go long". Time decay is what they are reffering to.

In reference to the horizontal time spread, a trader or investor can capitalize off of the rich premium associated with selling the near term option contract, therefore reducing his or her cost on the longer term stock option. This can translate into a profitable option position once the spread begins to widen.

As mentioned before, the Calendar spread option strategy can be positioned to have either a bearish,neutral or a bullish bias. Typically, a neutral set up would entail placing the spread closer to the price of the underlying stock price as opposed to further away, in either direction. The neutral nature comes from the fact that the investor does not have to anticipate direction of the stock. As long as the stock remains stable, the short options theoretical value deteriorates over time, translating into a profitable option position.

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