If you hate range-bound and low volatility markets, then you may want to try trading a calendar spread, writes the staff at optionalpha.com. But if you’re a beginner you might ask “Is this strategy good for me or will I get burned?”
If you’ve never traded options before, I would stay away for now until you get your feet wet. On the other hand, if you have good understanding of basic options trading principals then calendar spreads could be a useful strategy.
Quick Calendar Spread Basics
As always we need to first identify what a calendar spread is and isn’t.
Calendar spreads are extremely versatile and often are called horizontal or time spreads. As the name implies you are trading different contract months to take advantage of pricing differences between the expiration periods. Aren’t traders just so clever with their names!
Building a calendar spread is very easy (even for beginners)…
The most common spread is built by selling either calls or puts of an option contract with near-term or front-month expiration and then simultaneously purchasing either calls or puts of the same strike price for a further out expiration month.
Since you are purchasing a traditionally more expensive option and selling a cheaper option you’ll usually have a debit on the trade or pay to enter the position overall. Your P/L diagram will look like something similar to the one below with $135 strike price options used as an example.
Calendar Spread Theoretical Profit/Loss Graph
How do you make money, then? Well, now that you are pinned at the same strike you are really not that concerned about the movement in the underlying stock. This is why the strategy works best in range-bound markets.
Instead you want to take advantage of the time decay premiums between the two contract months. The near-term option will have much quicker time decay than the further month option. The idea is to pin-point and capture this difference as a profit and exit the trade before the near-term contract expires.
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