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Track 'n Trade Futures End of Day Options

Calendar Spread

Video Transcript

In this Track 'n Trade Pro Options trading training video, I want to talk to you about calendar Spreads, or also known as calendar time spreads. When an Option has several months remaining before expiration, time decay is relatively slow. As time goes by the rated time decay, the Options theta increases. When the Option has less than 30 days remaining, time decay goes into high gear. Calendar or time spreads, take advantage of this characteristic. In a typical horizontal calendar spread, you sell an option, at the same time you buy your Option of the same type, Call or Put, on the same underlying commodity. At the same strike price, as well. But with a further expiration.

For example: If the commodity is trading at 98.70, you would buy 1 June 98.70 Call with 75-100 days. You would sell 1 March 98.70 Call with maybe 30-60 remaining.

Here's how it works: The March 98.70 Call will lose premium faster than June 98.70 Call; causing the spread to widen. The value of the Spread will increase. The ideal situation would be that the underlying Futures contract to be trading at 98.70 when the March Call expires. It would then expire worthless. While the June 98.70 Call, now with 45 or more days remaining, instead of 75, would still have time premium. Basically, equal or close to what you paid for it. So, the calendar spread, which cost you roughly $200.00 would now be worth approximately $800.00 for a profit of $600.00. Of course, there would be commissions, and bid ask slippage, but you get the idea of how this time spread strategy works.

Here are some additional considerations for this strategy. The market should be in a trading range, the narrower the better. Any big move, up or down, will hurt this positions, and may result in a loss. The Options you sell should be over-valued. Relative to the Options you buy. This will help to stack the odds in your favor. It helps if implied volatility is increasing. This will increase the time value premium of the Options you purchase, which have more time remaining than the Options you sell in a calendar spread.

In a calendar spread, the Options you buy have more time remaining, hence a larger vega, than the Options you sell. The vega decreases as an Options expiration approaches. Which means, that an increase in volatility will cause the price of the Options you bought to increase, more than the Options you sold. This helps your position.

Of course, if you stay in the calendar spread until the Options you sold expire, they will expire without any time value. Whereas the Options you bought, will still have some time value remaining.

When you find a good calendar spread market, make sure you identify the profit zone. That is, the price range, which the underlying has to stay within for this strategy to be profitable.

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