What Is A Calendar Spread? | Option Strategy Basics | IBD | Summary and Q&A

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May 17, 2023
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Investor's Business Daily
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What Is A Calendar Spread? | Option Strategy Basics | IBD

TL;DR

Calendar spreads are a low-risk option strategy that profit from time decay and increased implied volatility.

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Questions & Answers

Q: What is a calendar spread and how does it work?

A calendar spread is an option strategy that involves buying an option with a longer expiration date and selling an option with a shorter expiration date on the same underlying asset. The goal is to profit from time decay and an increase in implied volatility.

Q: When would traders use call options in a calendar spread?

Traders typically use call options in a calendar spread unless they have a bearish bias. By selling a call option in a near-term expiration cycle and buying a call option in a longer-term expiration cycle, traders aim to profit from the passage of time and an increase in implied volatility.

Q: How can traders set up a call calendar spread?

Traders can set up a call calendar spread by buying a call option with a longer expiration and a specific strike price and simultaneously selling a call option with a shorter expiration and the same strike price. The options should be on the same underlying stock.

Q: What are the potential risks and rewards of a calendar spread?

The maximum possible loss for a calendar spread is the net premium paid for the trade. The maximum profit occurs if the stock finishes at the strike price at expiration of the sold option. The exact profit and break-even area may vary due to the differing expiration cycles used.

Summary & Key Takeaways

  • Calendar spreads involve using the same underlying asset and strike price for each leg of the trade but different expiration dates.

  • The strategy can be employed using either two calls or two puts, depending on the directional assumption.

  • Traders look for stocks with low implied volatility and set up the spread to take advantage of an increase in volatility.

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