What is a Calendar Spread?

A calendar spread, also known as a time spread, is an options trading strategy in which a trader buys and sells the same type of option (call or put) at the same strike price but with different expiration dates.

Important Features:

Same price for the strike
Same asset underneath
Different dates for expiration
You usually sell the option that is about to expire and buy the one that is going to last longer.
What is the point of using a calendar spread?

Traders use calendar spreads to take advantage of differences in time decay (theta) and/or volatility between short- and long-dated options.

This plan is often:

Not going in any one direction (not expecting prices to move much in the short term)
Based on volatility (expecting future volatility to rise)
Calendar Spreads of Different Kinds

You can use either calls or puts to make calendar spreads:

Call Calendar Spread: Buy a call with a longer expiration date and sell a call with a shorter expiration date.
Put Calendar Spread: Buy a put option with a longer expiration date and sell a put option with a shorter expiration date.
In terms of structure and payoff, they both act the same.

How It Works: An Example

Let's say you're trading AAPL (Apple Inc.), which is now worth $170.

You think:

For the next two weeks, the price will stay around $170.
After that, volatility may go up. You start a Call Calendar Spread:

What to do

Type of Option

Hit

End of Validity

Cost

Sell

Call

$170

It's only ten days until October 4.

Two dollars

Get

Call

$170

November 1 (in 40 days)

$4.50

Net Debit = $4.50 - $2.00 = $2.50 per share, which is $250 per contract.

Profit and Loss (P&L) at the End

Your short call (October 4) runs out first.
The goal is for AAPL to be close to $170 at that time.
If AAPL is close to $170, the short option loses value the fastest, while the long option keeps more value. This is where you can make money.
If AAPL moves too far away from $170, the short option becomes more valuable, which eats into profits (or causes a loss).
Payoff Profile (due on October 4):

Most profit: When AAPL closes at $170
The breakeven zone is It depends on implied volatility and pricing, but it's usually within a few dollars of $170.
Maximum loss: Only the net debit paid ($2.50)
What Makes Profits Go Up?

Theta, or time decay
The option with the shorter expiration date loses value faster than the one with the longer expiration date. This is your edge.
Volatility (Vega): Calendar spreads do better when implied volatility goes up, especially for the longer-term option.
Change in Price (Delta)
The underlying should stay close to the strike.
Calendar Spreads: What Are the Risks?

Directional risk: The trade can lose money if the stock moves too far away from the strike.
Volatility crush: If implied volatility goes down after you enter, the long option may lose value more quickly.
Assignment risk: If the short option goes in the money close to the end, you might have to do it early.
Changing the Trade

You can roll the short option to a different strike if the stock moves too far away (this makes a diagonal spread).
If volatility goes up sooner than you thought it would, you might want to close the trade early to keep your profits.
Realistic Situations

Price of AAPL on October 4

Result

One hundred seventy dollars

Best case scenario: the zone of maximum profit

$165 or $175

Small profit or break-even

$160 or $180

Possible loss depending on how volatile it is

$185 or less than $155

Most likely, the $2.50 premium will be lost completely.

The Good and Bad of Calendar Spreads

Pros:

Low risk (as measured by net debit)
Good for views that are neutral or slightly directional
Take advantage of the rise in volatility
Able to be changed and adjusted
Disadvantages:

Sensitive to big changes in price
Need to be timed well; hard to manage near the end
When to Use a Calendar Spread

You think the stock will stay close to a certain price.
You think that volatility will go up after the short leg ends.
Earnings or events are planned for after the near-term expiration.
Last Thoughts

Calendar spreads are a great tool for traders who know how time decay and volatility work. They need careful management, but if you do the right research and time them right, they can be very rewarding.