calendar spreads ?

Discussion in 'Options' started by Andy_Trade, Nov 21, 2007.

  1. Hello,

    Any fans of calendar spreads here? I'd like to hear about their use and how much people like them and for what reasons.

    In particular It would be helpful to know what type of situation would be best to implement a calendar spread and why.

    Thanks to all who reply.
  2. I've dabbled in calendars, haven't traded them much.

    Like any other combination with a short leg, the calendar is a bet on the short leg expiring at the money. In particular, as long as your short legs keep expiring ATM you can roll out to the next month for maximum credit.

    The position becomes less profitable in either direction as you move away from the strike, because both options will converge to parity. Your long leg should be a couple months longer in time than you expect the stock to behave itself. Any longer, and you overpay for time premium because eventually the stock will leave your strike price in the dust and you won't be able to keep writing that strike.

    The calendar should not give you much exposure to volatility, unless you have a very long-term long leg or an IV skew between your long month and your short month. Incidentally, a calendar is a good limited-loss play to take advantage of a skew with higher IV in the front month and lower IV in the out month.

    Last point: Call calendars and put calendars are equivalent.
  3. Thanks.

    So I wouldn't want to get in a position with high IV due to the premium I could lose if there is a big contraction?

    And it would be better to have higher IV in the near month in case there is contraction so it will hit the sold leg more than the long?

    All I really know is price per day to take advantage of buying the cheaper option per day and trying to profit from the time decay of the short option.

    I just don't want any surprises like so many new traders get when they overlook important things like IV ect. I've played around with the TOS simulator for awhile now and it's shocking how far off the P/L analyzer can be when it comes to things like volatility.

    A max loss potential from now until a few days from now on the P/L tool could say 40 bucks but then I end up losing 300 the next day.
  4. If the options are a month or two apart with similar IV, any IV contraction should hit them similarly. The calendar is not usually an IV play unless you open it when there is a skew between months. Though I'm willing to be corrected on this point.

    Where IV contraction will hurt you is at expiration of your short leg. At that time, you'll want to either sell your long leg or write another month, and low IV will take a bite out of your profits at that point.

    Ideally, yes. You should be able to collect more premium per day from the short leg even at the same IV, but higher IV in the front month always helps.

    At least you know that in a debit calendar you can't lose more than your initial cash outlay, which is less than the price of the long leg.
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  6. In and of itself, a calendar is a neutral position where you expect (hope?) the underlying will expire near the strike sold.

    Some other possibilities include:

    1) Using them as bullish or bearish strategies (buying them OTM),

    2) Double calendars (what I call calendar straddles and strangles) which can be ratioed to add some bang for the buck

    3) Volatility plays where you hope to collect more from an IV contraction of one leg vs that lost on the other leg, or vice versa.

    4) Reverse Calendars for special situations

    1) Standard application is to buy a long calendar with the goal of the underlying finishing near the strike, ending with a reduced cost far month long option. I think this is a fool's errand since who knows where an underlying will be a month from now? If one knew that, one would be Miss Cleo. I say fool's errand because the bane of calendars is a move away from the strike thereby forcing the legs toward parity. Since the long leg cost more, it loses more $$ and the position fails.

    2) Double calendars are interesting and what strike and ratio you use (if any) will depend on IV skew (if any) expectation/prediction of movement in the underlying, expectation of IV change, and risk tolerance. You can tailor some interesting risk graphs from these.

    3) This ties in with #2 and #4. For earnings plays with skew, you're getting more risk premium for selling the near month and that gives you more tolerance for an adverse move. But just because you're selling a more over valued near month, even with an IV collapse, the far month can still lose more $$ because it cost more to start with.

    4) Reverse calendars and particularly double reverse calendars (aka double reverse straddles) are interesting for that rare situation where vols are way out of line in all months just before a news release as well as for earnings releases the last week before expiration where a contraction (hopefully a collapse) in vols and/or price movement moves the underlying away from the strike sold. In some situations you can ratio a calendar strangle, giving yourself some extra cushion if the underlying goes nowhere and some initial directional profit if it goes somewhere but of course, not too much direction since the extra short ratioed legs then come into play and begin to hurt you. Look for a chain here by IV Trader who introduced this strategy to a lot of us.

    Every option strategy has potential surprises. IMHO, everything is a trade off of risk and reward and you have to find a balance in a position that you can swallow. Calendars are no different. There's always an area in the risk graph that costs you. By combining them, you can take some of the pain of a directional move out but that introduce some risk elsewhere. So it all depends on where you want your pain located :)
  7. Yes and no on the IV contraction hitting them similarly. If there's no more than the small skew that you normally see in closer months, a large IV contraction is going to shrink the far month more dollar-wise than the near month. Only higher front month skew will push this more towards similar.

    Although more skew is good skew, you don't necessarily have to have it in order to chase a volatility play. It's gravy but it's not mandatory. If all months are up before an EA, all will contract and assuming that they contract reasonably equally, double calendars (strangles or straddles) can benefit nicely.

    It's kinda of hard to specific when you're speaking in general (g) since there are multiple variables and multiple situations. It all depends on what the pre EA circumstances are as well as the strategy implemented as well as the post EA results (IV contraction and/or underlying movement). Because of this, each strategy can have a variety of results.