.jpg)
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 JP Morgan Chase (JPM), Netflix (NFLX) and Goldman Sachs (GS).
JPM Neutral Calendar Spread
Let’s use JPM stock for our first calendar spread example.
With JP Morgan Chase stock trading around $200, setting up a calendar spread at $200 gives the trade a neutral outlook.
Selling the April 19 put option with a strike price of $200 will generate around $375 in premium, and buying the May 17, $200 call will cost approximately $580.
That results in a net cost for the trade of $205 per spread, and that is the most the trade can lose.
The estimated maximum profit is $365, but that could vary depending on changes in implied volatility.
The idea with the trade is that if JPM stock remains around $200 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 $191 and $212, but these can also change slightly depending on changes in implied volatility.
In terms of trade management if JPM broke through either $191 or $212, I would look to adjust or close the trade.
JP Morgan Chase is due to report earnings on April 12.
Let’s look at another example.
NFLX Neutral Calendar Spread
With Netflix stock trading around $630, setting up a calendar spread at $630 gives the trade a neutral outlook.
Selling the April 19 call option with a strike price of $630 will generate around $2,840 in premium, and buying the May 17, $630 call will cost approximately $3,840.
That results in a net cost for the trade of $1,000 per spread, and that is the most the trade can lose.
The estimated maximum profit is $2,360, but that could vary depending on changes in implied volatility.
The idea with the trade is that if NFLX stock remains around $630 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 $570 and $715, but these can also change slightly depending on changes in implied volatility.
In terms of trade management if NFLX broke through either $570 or $715, I would look to adjust or close the trade.
Netflix is due to report earnings on April 18.
GS Neutral Calendar Spread
With Goldman Sachs stock trading around $410, setting up a calendar spread at $410 gives the trade a neutral outlook.
Selling the April 19 call option with a strike price of $410 will generate around $940 in premium, and buying the May 17, $410 call will cost approximately $1,470.
That results in a net cost for the trade of $530 per spread, and that is the most the trade can lose.
The estimated maximum profit is $690, but that could vary depending on changes in implied volatility.
The idea with the trade is that if GS stock remains around $410 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 $393 and $432 but these can also change slightly depending on changes in implied volatility.
In terms of trade management if GS broke through either $393 or $432, I would look to adjust or close the trade.
Goldman Sachs is due to report earnings on April 15.
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.
