Definition
The term calendar spread refers to a neutral strategy that involves options with the same underlying stock and strike price but different expiration dates. Calendar spreads are a low risk, low return option strategy that profits from volatility and the passage of time.
Explanation
Also referred to as a time or horizontal spread, a calendar spread is constructed using call or put options with identical strike prices, but different expiration dates. The outlook for the stock should be directionally neutral since the approach leverages the concept of time decay. That is to say, as an option contract approaches its expiration date, the ability to predict its terminal value also increases.
Calendar spreads are constructed using options of the same type (call or put) and the same strike price. For example, the investor can combine a short call with a near term expiration date and a long call with a longer-term expiration date. Since the strategy is neutral, both calls will be at-the-money or slightly out-of-the-money.
Due to decay, the near-term option will decline in value faster than the longer-term option. The maximum loss the investor can incur is the premium paid to establish the position. After the near-term option expires, the investor is left with a long call that possesses theoretically unlimited profit potential.
Related Terms
The term butterfly spread refers to a neutral strategy involving a combination of bull and bear spreads using three strike prices. Butterfly spreads are considered a limited profit, limited risk option strategy.
Moneyzine EditorJanuary 9th, 2024
The term box spread refers to a four-sided option involving a bear and bull spread with identical expiration dates. Box spreads can provide the investor with an arbitrage opportunity, with the trader assuming a nearly riskless position.Moneyzine EditorJanuary 9th, 2024
The term backspread refers to an investment strategy that involves buying more long position options than short positions. Backspreads provide the investor with relatively large exposure to any movement in the underlying security.Moneyzine EditorJanuary 8th, 2024
The term averaging down refers to an investment strategy that involves buying additional shares of stock at a lower price than originally paid. Averaging down effectively lowers the average price paid per share of stock.Moneyzine EditorJanuary 8th, 2024
