Most strategies bet on where a stock goes. A calendar spread is different: it bets on time. It profits from the simple fact that a near-term option loses its value faster than a longer-term one, even when both sit at the same strike.
Think of two candles at the same spot, a short one and a tall one. The short candle burns down much faster. You sold the short candle and bought the tall one, so you pocket the difference as the short one melts away first.
Sell the near month, buy a later one
A calendar spread has two legs at the same strike. You sell a near-term option, which decays quickly, and you buy a longer-term option, which decays slowly. Since the option you sold loses value faster than the one you bought, that gap works in your favor. When the near-term option expires, you can often sell another against your remaining long option and do it again.
The sweet spot
A calendar spread does best when the stock hovers near the strike you chose. That is where the near-term option you sold decays most completely, while your longer-term option keeps most of its value. A big move in either direction is the enemy, because it can push both options around and shrink the gap you were counting on.
A gentle warning
Calendar spreads add a wrinkle the earlier strategies did not: they are sensitive to volatility as well as time, so the two legs can behave in ways that surprise beginners. The risk is limited to what you pay to set it up, which is nice, but the mechanics take some getting used to. Treat this as a step up once the simpler income trades feel comfortable.
The whole edge is that short candles burn faster than tall ones. As long as the stock stays near your strike, time does the work for you, one near-term option at a time.
- A calendar spread sells a near-term option and buys a longer-term one at the same strike.
- It profits because the near-term option decays faster, and you keep the difference.
- It does best when the stock stays near the strike, and its volatility sensitivity makes it a step up from basic income trades.
This article is educational and is not investment advice. Options involve risk, including the possible loss of principal. Examples and premiums shown are illustrative and change with the market. Practice with paper trading before committing real money.