Equodity

Calendar spreads are also known as time or horizontal spreads because they involve options with different expiration months. In this case, “horizontal” refers to the fact that option months were originally listed on the board at the exchange from left to right. At the same time, strike prices were listed from top to bottom. For this reason, options with different strike prices and the same expiration are often referred to as vertical spreads.

Typically you want to look for a company who’s share price doesn’t change much over time. This spread takes advantage of time erosion and not stock movement. So as long as the volatility doesn’t play a roll in an options price when approaching expiration the time value should deteriorate nicely and you lock in your profit.

A long calendar spread involves buying an option with a longer expiration and selling an option with the same strike price and a shorter expiration. For example, imagine that Microsoft (MSFT) is trading for $$27.50 per share. To initiate a calendar spread, you might sell the MSFT April 27.50 calls and buy the July 27.50 calls.

Option	Bid	Ask	Time to Expire	Open	Strike
Apr 08	1.67	1.69	2 Months	15,665	27.50
July 08	2.56	2.60	5 Months	5,295	27.50

Like most long positions, there is a cost to put on this trade. In this case, the cost is $0.93. For the time spread to work, the April option must lose its time premium faster than the July option. If the stock price remains relatively stable as the April expiration approaches, the value of the spread should increase. With only one month remaining before the April expiration, the option prices might look like this.

Option	Bid	Ask	Time to Expire	Open	Strike
Apr 08	.25	.27	1 Month	25,685	27.50
July 08	2.31	2.34	4 Months	15,639	27.50

In this case, the position could be closed for a 1.11 profit by selling the July calls and buying back the April calls.

For long calendar spreads to work, the underlying stock price must remain relatively stable. Volatility is the enemy of a calender spread, any swings in either direction will negatively impact the time value of both options causing the spread to lose value. So plan your spreads appropriately, dont put one on over an important earnings period or when you know a major announcement about the company is due.

(MSFT: 17.53 0.00%, vol: 0, avg vol: 100,689,000)