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 take a look at Barchart’s Long Call Calendar Screener for April 6th.
I have added a filter for Market Cap above 40b and total call volume above 2,000 to remove small capitalization stocks.
The screener shows some interesting calendar spread trades on popular stocks such as SCHW, META, C, JPM, TSLA, MS, VLO, IBM and XOM. Let’s walk through a couple of examples.
SCHW Calendar Spread Example
Let’s use the first line item as an example.
With Charles Schwab stock trading at 48.87, setting up a calendar spread at 50 gives the trade a roughly neutral outlook.
Selling the April 21 call option with a strike price of 50 and buying the May 19, 50-strike call will cost around $111. That is also the most the trade can lose.
The estimated maximum profit is $200, but that could vary depending on changes in implied volatility.
The idea with the trade is that if SCHW stock remains around 50 for the next few days, 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 45 and 56, but these can also change slightly depending on changes in implied volatility.
In terms of trade management if SCHW broke through either 45 or 56, I would look to adjust or close the trade.
Let’s look at another example.
META Calendar Spread Example
With Meta Platforms stock trading at 211.48, traders could sell the 210-strike April 28th call and buy the 210-strike May 19th call.
That net cost for the trade would be around $290 per spread, and that is the most the trade can lose.
The estimated maximum profit is $800, but that could vary depending on changes in implied volatility.
The breakeven prices for the trade are estimated at around 188 and 238, but these can also change slightly depending on changes in implied volatility.
JPM Calendar Spread Example
The last example we will look at is on JPM stock.
With JP Morgan stock trading at 127.61, traders could sell the 130-strike April 21st call and buy the 130-strike May 19th call.
That results in a net cost for the trade of $198 per spread, and that is the most the trade can lose.
The estimated maximum profit is $250, but that could vary depending on changes in implied volatility.
The breakeven prices for the trade are estimated at around 124 and 137.50 but these can also change slightly depending on changes in implied volatility.
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.
