The Calendar Spread is an option cash-flow technique that is loved by both pro option traders as well as the retail crowd to create a consistent monthly income.
The calendar spread is a theta trade – an option trade that benefits and generates profit – from the fact that options are a decaying asset. As time goes by, options decay – and the value that was initially in the option that was sold evaporates – leaving cash in the calendar spread traders pocket.
These trades can be built from call options as well as put options. In order to create a calendar spread trade, the option trader sells a near month strike on an underlying vehicle – and then buys a later month at the identical strike. Profit can be made from this trade because what happens over time is that the time premium in the closer month option decays at a much faster speed than the later month option. What is left over at expiration day is the difference of the two – which is what gives the trader profit.
Following is a made up example of a calendar spread place on SPY: Buy 1 Aug 105 call. Sell 1 Sept 105 call.
Now while in the example above the calendar position was created using joined together months, calendar spreads can also be created with a gap between the months.
As a sample, rather than use May 35 puts – one could instead use June 35 puts – or July.
Usually this strategy is employed when the person trading it has a neutral outlook on the the vehicle being traded. These trades cal also be used in a more speculative way however – where the trader would place the calendar spread at the strike price he or she believes the underlying vehicle will be trading at on expiration day.
It is a common belief that the calendar spread is easier to manage than some of the other option trading strategies that are out there – which might explain why they are so preferred to technique like the iron condor, the butterfly, and / or the credit spread. Nevertheless – what is mutually agreed upon is that the calendar spread strategy is definitely a technique serious option traders should learn and have it ready to be put to use when needed.
Want to find out more about the Calendar Spread, then visit David Harms’s site on how to choose the best Credit Spread for your option income trading needs.