The calendar spread options strategy is a market neutral strategy for seasoned options traders that expect different levels of volatility in the underlying stock at varying points in time, with limited risk in either direction. The goal is to profit from a neutral or directional stock price move to the strike price of the calendar spread with limited risk if the market goes in the other direction.
What is a calendar spread?
A calendar spread typically involves buying and selling the same type of option (calls or puts) for the same underlying security at the same strike price, but at different (albeit small differences in) expiration dates. This type of strategy is also known as a time or horizontal spread due to the differing maturity dates.
A typical long calendar spread involves buying a longer-term option and selling a shorter-term option that is of the same type and exercise price. For example, you might purchase a two-month 100 strike price call and sell a one-month 100 strike price call. This is a debit position, meaning you pay at the outset of the trade.
Calendar spreads are for experienced, knowledgeable traders
In technical terms, the calendar spread provides the opportunity to trade horizontal volatility skew (different levels of volatility at two points in time) and take advantage of the accelerating rate of theta (time decay), while also limiting exposure to delta (the sensitivity of an option's price to the underlying asset). The horizontal skew is the difference of implied volatility levels between various expiration dates.
The goal of a calendar spread strategy is to take advantage of expected differences in volatility and time decay, while minimizing the impact of movements in the underlying security. The objective for a long call calendar spread is for the underlying stock to be at or near, nearest strike price at expiration and take advantage of near term time decay. Depending on where the stock is relative to the strike price when implemented the forecast can either be neutral, bullish or bearish.
Calendar spread candidates
You can use some of the tools that are available on Fidelity.com to search for calendar spread opportunities. For example, if you select “IV 30 > HV 30” as the criterion, the scan will look for elevated IV levels relative to historical volatility (HV) levels. This specific screen may indicate that certain options are “expensive.”
One-year implied volatility chart
Source: Fidelity.com. Screenshot is for illustrative purposes only.
The profit/loss diagram of a calendar spread shows that when the stock price increases, this type of trade suffers. Significant movement in either direction in a short period may be costly because of the way the higher gamma (the rate of change, or sensitivity, to a price change in the underlying security for delta) affects short-term contracts.
Another risk to this position is early assignment when selling shorter-term contracts (especially with calls), where the expiration date follows the ex-dividend date. If this is the case, the probability of assignment increases significantly. If assignment occurs prior to the ex-dividend date, the client will owe the dividend payment because the account is now short shares, unless shares of the underlying security are already held in the account.
Early assignment also changes the strategy from a calendar spread to a synthetic long put if you don’t already own shares, because you are short a stock and long a call, which is a very different outlook.
Managing a calendar spread
It is also advisable to check for ex-dividend dates, as it is very important to understand assignment risk—especially for call spreads. You can adjust the spread as necessary to maintain the long position, while adjusting the strike price of the short contract along the way to give more delta exposure.
Calendar spreads with Fidelity
A client needs at least a "level 3" option approval to implement this strategy.
When the short-term expiration date approaches, you will need to make a decision: Sell another front-month contract, close the whole strategy, or allow the long-term call or put to stay in place by itself.
Options trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. Before trading options, please readCharacteristics and Risks of Standardized Options.Supporting documentation for any claims, if applicable, will be furnished upon request.
There are additional costs associated with option strategies that call for multiple purchases and sales of options, such as spreads, straddles, and collars, as compared to a single option trade.
Greeks are mathematical calculations used to determine the effect of various factors on options.
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The answer depends upon whether the assignment occurred at expiration or prior to expiration (i.e., an American Style option). At expiration, many clearinghouses employ an exercise by exception process intended to ease the operational overhead associated with the provision of exercise instructions by clearing members. In the case of US securities options, for example, the OCC will automatically exercise any equity or index option which is in-the-money by at least $0.01 unless contrary exercise instructions are provided by the client to the clearing member. Accordingly, if the long option has the same expiration date as the short and at expiration is in-the-money by a minimum of the stated exercise by exception threshold, the clearinghouse it will be automatically exercised, effectively offsetting the stock obligation on the assignment. Depending upon the option strike prices, this may result in a net cash debit or credit to the account.
If the assignment takes place prior to expiration neither IB nor the clearinghouse will act to exercise a long option held in the account as neither party can presume the intentions of the long option holder and the exercise of the long option prior to expiration is likely result in the forfeiture of time value which could be realized via the sale of the option.