The Calendar Spread Option Trade
The Calendar Spread, also known
as the Time Spread is a favorite strategy of many
option traders, especially market makers.
The Calendar is basically a play
on time and volatility. It is comprised of two
options, both at the same strike price. One is
a near month option, which is sold. The other
is a farther out option which is bought. So you
are selling a near term option and buying a farther
out term option and paying for the trade. Thus,
the Calendar Spread is a debit trade.
The Calendar Option
Spread Makes Money in Two Ways.
The first is with time decay. The
sold option will decay faster than the long term
option. As long as the underlying instrument stays
near the strike price.
The second way a Calendar Trade
makes money is with an increase in volatility
in the far month option or a decrease in the volatility
in the short term option. If there is a rise in
volatility, the option will gain value and be
thus worth more money. So if the underlying drops
in price, chances are the volatilities of both
options will increase.
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The Benefits
of Calendar Spreads
There are several benefits to the
Calendar Option trade.
1. It is relatively inexpensive.
You can put these trades on for just a few dollars
in lower priced stocks.
2. It is easy to adjust. There are
many calendar spread adjustments to choose from
and they are very simple to implement.
3. Since the calendar is a debit
trade, the maximum a trader can lose is the amount
of the debit and thus risk is limited.
4. The risk/reward is great.
5. If there is a rise in volatility,
the trader can make 20-30% or more in just a couple
days.
Here's an example of a Calendar
Spread Trade that I posted on my blog as a papertrade
and traded it like a normal trade.
Calendar Spread Trade Video. The video is
a little grainy.
GLD (ETF for Gold) at the time was
trading at 125.50.
The Calendar was entered by Selling
the Oct 125 Calls and Buying the Nov 125 Calls.
This set the breakevens on the trade at 122.07
on the low side and 128.14 on the high side.
What we wanted was to have GLD stay
within the breakevens and as close to 125 as possible.
But that was not to be. GLD continued to advance
and was soon outside of the upside breakeven.
So what I did was added another
calendar to the trade.
Double Calendar
Spread
I turned the singular calendar into
a double calendar by adding the Oct/Nov 128 Call
Calendar Spread. Now I had two calendars and my
breakevens became 123.61 and 129.59. The adjustment
doubled my margin.
As the days passed, GLD kept moving
higher, all the way to 130.70. My options were
to remove the 125 Calendar, or add a third calendar
and make the trade into a triple calendar. I did
not think GLD was going to pull back so what I
did was take off both the 125 and 128 Calendars
and replaced them with a double calendar at the
130 and 133 strikes. The breakevens became 129.39
and 133.77. By this time I was down $450 in this
trade on margin of $3,200.
The next few days, GLD calmed down
and not only did the trade get back into positive
territory it made money. Watch the video for the
details.
This was not a textbook example
of a calendar spread. As you can see, everything
did not work well and I was forced to monitor
and adjust the trade twice. But I think the example
shows that this strategy is simple to trade and
can make money even when things do not go the
way you expected them to.
Overall, Calendar Spreads are a
great option strategy to make decent returns with
limited risk in short amounts of time. Most traders
enter Calendar Spreads with 30 days or less to
expiration to take advantage of the increased
time decay during this time.
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Common Calendar
Spread Questions
1. How do you find stocks to trade
Calendar spreads on?
Normally you want a stock that is
not too volatile. I know some traders that make
good money trading calendars on IBM every month.
Any DOW stock can make a good candidate as long
as there is enough premium in the options.
2. Can I trade Calendar Spreads
on Weekly options?
Yes you can. But I have found that
with the weeklys, you have to stay on top of the
trade and adjust several times. The commissions
eat a lot of the profit. Especially since you
have to trade a greater number of calendars in
the weeklys because the premium is lower than
regular options.
3. What is the risk when trading
Calendar Spread options?
The risk is the amount you pay for
the trade. Since a Calendar Spread is a debit
trade you have to pay for it. This amount is the
max you can lose.
4. Is it true you can make 100%
or more on a Calendar Spread?
Yes you can, but it is very rare.
In order to make that much you have to be in the
trade until expiration and have the stock be extremely
close to your strike. 100% is possible but I aim
for 20% on my calendar trades.
So what do you think? Please leave
your comments below.
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