The Calendar Spread – Option Trading Strategies & Analysis

The Calendar Spread: In my last post I listed a Free Trade on POT which is called a Calendar Spread, also known as a Time Spread.

In that trade we sold the Oct 90 Calls and Bought the Nov 90 Calls.

The trade makes money when POT stays in range around 90. Basically what we want is the Oct option to decay and lose value while the Nov option (which we bought) retains its value. Time Decay quickly erodes an option’s value, especially in the last 30 days. That is why I prefer to put these types of trades on with 30 or fewer days left for the front month.

We enter this trade with a debit meaning we paid for the trade. That is because the Nov option was more expensive than the Oct option because the Nov option has more time premium.  POT also has earnings after the Oct option expires which means that the volatility (value) of the Nov option will be elevated (at least a little more than normal).

Calendar spread option strategy

What we want is for POT to stay in between the break evens until it gets close to expiration. The Oct option loses value everyday and that is how we make money. During the last few days before expiration the fluctuations in prices can move wildly.  That is why I prefer to be out of this trade before expiration week. But in this trade we put it on pretty late and will have to stay in longer.

To exit a Calendar Spread you have to sell it. Otherwise you will still be holding the back month (Nov) option even if the front month (Oct) expires.

The beauty of Calendar Spreads is that they are cheap to trade, easy to adjust, and can result in large profits – 20-40% is common. You can also keep your losses small.

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1 Comment

  1. Xueren Zhang on October 13, 2009 at 7:32 pm

    OG,I love the calendar spread of POT you suggested,even though I didn’t do it.Today,I looked ONN.TV.It has also published an idea of trading HAL calendar spread ( sell OCT 29,buy NOV 29),Wwhich is kind of your trade of POT,and time is really short and earning related.

    I like you to recommend more calendar spreads.Your Sept PEP calendar spread was excellent,because you had plenty time to exit.

    Xueren

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