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 Nike (NKE), Microsoft (MSFT) and Goldman Sachs (GS).
NKE Neutral Calendar Spread
Let’s use NKE stock for our first calendar spread example.
With Nike stock trading around $110, setting up a calendar spread at $110 gives the trade a neutral outlook.
Selling the August 18 put option with a strike price of $110 will generate around $260 in premium, and buying the September 15, $110 call will cost approximately $400.
That results in a net cost for the trade of $140 per spread, and that is the most the trade can lose.
The estimated maximum profit is $150, but that could vary depending on changes in implied volatility.
The idea with the trade is that if NKE stock remains around $110 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 $106 and $115, but these can also change slightly depending on changes in implied volatility.
In terms of trade management if NKE broke through either $106 or $115, I would look to adjust or close the trade.
Let’s look at another example.
MSFT Neutral Calendar Spread
With Microsoft stock trading around $335, setting up a calendar spread at $335 gives the trade a neutral outlook.
Selling the August 18 call option with a strike price of $335 will generate around $785 in premium, and buying the September 15, $335 call will cost approximately $1,280.
That results in a net cost for the trade of $495 per spread, and that is the most the trade can lose.
The estimated maximum profit is $500, but that could vary depending on changes in implied volatility.
The idea with the trade is that if MSFT stock remains around $335 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 $324 and $350, but these can also change slightly depending on changes in implied volatility.
In terms of trade management if MSFT broke through either $324 or $350, I would look to adjust or close the trade.
GS Neutral Calendar Spread
With Goldman Sachs stock trading around $355, setting up a calendar spread at $355 gives the trade a neutral outlook.
Selling the August 18 call option with a strike price of $355 will generate around $690 in premium, and buying the September 15, $355 call will cost approximately $1,015.
That results in a net cost for the trade of $325 per spread, and that is the most the trade can lose.
The estimated maximum profit is $400, but that could vary depending on changes in implied volatility.
The idea with the trade is that if GS stock remains around $355 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 $345 and $366 but these can also change slightly depending on changes in implied volatility.
In terms of trade management if GS broke through either $345 or $366, 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.
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