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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 Exxon Mobil (XOM), Microsoft (MSFT) and Apple (AAPL).
XOM Neutral Calendar Spread
Let’s use XOM stock for our first calendar spread example.
With Exxon Mobil stock trading around 105, setting up a calendar spread at 105 gives the trade a neutral outlook.
Selling the December 15 call option with a strike price of $105 will generate around $250 in premium, and buying the January 19, 105 call will cost approximately $405.
That results in a net cost for the trade of $155 per spread, and that is the most the trade can lose.
The estimated maximum profit is $175, but that could vary depending on changes in implied volatility.
The idea with the trade is that if XOM 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 $101 and $110.50, but these can also change slightly depending on changes in implied volatility.
In terms of trade management if XOM broke through either $101 or $110.50, I would look to adjust or close the trade.
Let’s look at another example.
MSFT Neutral Calendar Spread
With Microsoft stock trading around $370, setting up a calendar spread at $370 gives the trade a neutral outlook.
Selling the December 15 call option with a strike price of $370 will generate around $770 in premium, and buying the January 19, $370 call will cost approximately $1,275.
That results in a net cost for the trade of $505 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.
The idea with the trade is that if MSFT stock remains around $370 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 $358 and $387, but these can also change slightly depending on changes in implied volatility.
In terms of trade management if MSFT broke through either $358 or $387, I would look to adjust or close the trade.
AAPL Neutral Calendar Spread
With Apple stock trading around $185, setting up a calendar spread at $185 gives the trade a neutral outlook.
Selling the December 15 call option with a strike price of $185 will generate around $440 in premium, and buying the January 19, $185 call will cost approximately $680.
That results in a net cost for the trade of $240 per spread, and that is the most the trade can lose.
The estimated maximum profit is $230, but that could vary depending on changes in implied volatility.
The idea with the trade is that if AAPL stock remains around $185 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 $179.50 and $193, but these can also change slightly depending on changes in implied volatility.
In terms of trade management if AAPL broke through either $179.50 or $193, 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.
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.
On the date of publication, Gavin McMaster did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
