Let Me Check My Calendar

Even if you're not that familiar with options, I'll bet you've heard someone use the term 'calendar spread'.

Whether or not they knew what they were talking about is another story.

So let's define it here.

Definition

A Calendar Spread (also known as a 'time spread' or 'horizontal spread') is when you sell (write) an option in one month and buy an option with the same strike price but in a different, further out month.

Since the option you're writing has less time (worth less) and the one you're buying has more time (will be worth more), this can also be referred to as a 'debit spread' as well.

You can do this with puts too – sell a put in a nearby month and buy the same strike in a further out month.

As you would expect, you'd have a neutral to bullish bias with the calls and a neutral to bearish bias with the puts.

You can also 'sell' this strategy by buying the nearby and selling the further out – but today, let's keep our focus on the long side.

Example

Let’s use IBM (IBM - Analyst Report) for this example.

• Let's say you wrote the December 125 call for 2.20 (collect $220) (delta is .35)
• And let's say you bought the April 125 call for 6.50 (paid $650) (delta is .45)
• net cost (debit) is 4.30 or $430

Why Would I Want to Do This?

The maximum potential loss is limited to what you paid for the spread – in this case $430.

The maximum profit if removed together would be the difference between the two option prices at the expiration of the nearby month.

Continuing with this example, let's say IBM closed under $125 by the time the nearby December option expired:

• At expiration, the December 125 call I wrote for $220 is now worth $0
• And the April 125 call I bought for $650 is now worth $540
• my calendar spread is worth $540
  $540 less my cost of $430 = profit of $110 or a 25% profit

If I wanted, I could hold onto that further out call if I thought a rally was underway – and make even more money.

But of course, if it went down, I could lose the rest of the premium. But again, my maximum loss would be limited to $430.

This is a great strategy.

Granted, you're limited in your profit potential, but you're capitalizing on the dynamics that the nearby month will lose its value (time value) quicker than the further out one.

Some people probably don't bother with this strategy because the profit potential seems small. But if you look at it in percentages, a 20% or 25% return isn't small at all. For example, if you put ten of these on, before commissions, that would cost $4,300. If you made $110 profit on each one, that's a $1,100 profit or 25%.

And that's pretty exciting.

You can learn more about this strategy and others by downloading our free options booklet: 3 Smart Ways to Make Money with Options (Two of Which You Probably Never Heard About). Just click here.

Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.