Calendar Spreads and Term Structure Trades

A calendar spread sells a near dated option and buys a longer dated one, profiting most when the stock pins near the strike.

A calendar spread sells a near dated option and buys a longer dated option at the same strike, expressing a view on the relationship between near term and longer term implied volatility rather than a direct bet on which way the stock moves. The position profits most when the stock sits close to the strike as the near dated leg expires, and loses ground when the stock makes a large move away from that strike before then.

Take a $100 strike call with 30 days to expiry priced at $5.20, sold, against the same $100 strike call with 60 days to expiry priced at $7.35, bought, on a stock at $102. The longer dated option costs more because it carries more time value, and the net debit to build the calendar is $7.35 minus $5.20, or $2.15.

The trade only fully resolves once both legs have expired, but the meaningful checkpoint is the near dated expiry at day 30, since that is when the short leg either expires worthless or gets assigned, leaving the trader holding just the remaining 30 days of the longer dated option.

If the stock pins at exactly $100 on day 30, the short call expires worthless. The long call, now itself a 30 day option at the same strike, is worth roughly what the original 30 day call cost, about $5.20, assuming volatility has not shifted. The position is worth $5.20 against the $2.15 paid, a profit of about $3.05, close to the maximum the trade can earn.

If the stock instead rallies hard to $130 by day 30, the short call that just expired owed $30 of intrinsic value, while the long call, now 30 days from expiry and deep in the money, is worth roughly its own intrinsic value plus a small amount of remaining time value, perhaps $30.40. The position is worth about $0.40 against the $2.15 paid, a loss of roughly $1.75, which shows the calendar losing exactly when the underlying view, that the stock stays near the strike, turns out to be wrong.