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Calendar Spreads

Calendar Spreads

Like Butterfly Spreads, Calendar Spreads are market neutral trades benefitting from time decay so they also fall in OM’s basic criteria.  They however radically vary from Condor family trades as they theoretically thrive on growing Vega (IV).  they are thus worth considering on their own right or as a separate complement in between Condors, where IV is low and expecting it to rise.

Calendar spreads are also called horizontal spreads (or time spreads), as opposed to vertical spreads in the same period (week, month etc.).

Calendar Spread

Yet, for information purposes, here are the main characteristics on a weekly or monthly Calendar (note that there is a dedicated page on weeklies / shorties; the topic will be extended later on)

  • Trade:

    • Sell the front week/month (generally current) about 25-35 DTE (~9-11 DTE on weeklies, back 2 weeks or monthly), and buy the back week/month (or further out, then often called campaign calendars).  There are many variants in the Calendar family, starting with Diagonals.
    • Use the same strike, either puts or calls.  Same trade, but possibly different premiums.  Also check for volatility skew on monthlies.
    • Generally place the short strike at or close to the current underlying’s price (ATM).
    • Margin is affordable, i.e. an interesting trade in terms of risk/return ratio.
  • Environment

    • Preferably low IV (bottom 1/3 of historical range), yet not so important for weeklies.
    • Expecting IV to rise (it is a Vega-positive trade), yet controlled enough not to move out of the tent.
    • Check for volatility skew between front and back period.  A positive skew is always preferable.  Check also the shape of the VIX term structure on VIXCentral.com
    • Calendars are slow positive Theta, hence one should enter early enough to capture time value.  The balance between Theta received (front) and Theta paid (back) depends how far out the long leg is.  It may end up being a fairly large debit spread.  Note that the short option will decay quicker.
    • Vega can hurt, but in the end Theta matters more, particularly on shorties.
  • Use along main OM’s “bread & butter” Weirdor strategy?

    • For adjustments? ONLY for the experienced trader.  Calendars are however used regularly in Rhino trades.
    • Anticipating the next month, i.e. back month to be used in next month’s position ? NO
    • As a Vega-positive complement in the options portfolio: CERTAINLY
  • Caution:

    • Calendars are hurt by negative Vega, and relatively more than Theta can bring in (at least early in the position).  They can lose value rapidly with a drop in IV on an up move.  A regular V/T ratio is 2-3 for weeklies, and up to 8 for monthlies
    • Don’t enter too late: you may just lose Theta and still be hurt by Vega !
    • Most Vega calculations are plain wrong ! One should be VERY careful particularly when the back month is far out (“campaign calendars”).  A common Vega corrector (weighted vega) is : Vega * square root (30/DTE) i.e. Vega for a 4 month out option should be halved (not so important for shorties).  That said, a number of seasoned Calendar traders like Himanshu Raval do not pay too much attention to that flaw.
    • Calendars are quite sensitive to large price moves; this is a concept that is relatively difficult to grasp for beginners (long Vega yet affected by price moves???).  While we can look at expiration breakeven points as exit points, one should be more careful early in the position.
    • Volatility skew is quite important when placing the trade.
    • The further out the back week/month is, the riskier is the trade in terms of Vega (theoretically…).  Unless you are experienced with campaign Calendars, only do that if for any reason you see a low Vega opportunity in the far out month.  IV must be close to its historical lows.
    • The further out the back week/month is, the more you pay for your debit spread, but Theta is more on your side.  There are trade-offs for each situation…
    • Gamma risk is higher on weeklies hence are closed latest 2-DTE.
    • Compared to Condors for instance, bet on a 40% success without adjustments (High Prob Condors: ~ 80%)
    • As it is very sensitive to volatility, one must ensure one uses the best possible pricing model…
  • Either an income or directional trade.  This is a typical “earnings” trade although price moves must yet be controlled.
  • Variants: Diagonals i.e. with different strikes.  However as we further look into versatile variants like Double Diagonals, characteristics tend to change a little.  For instance a Double Diagonal can be Vega-negative in some instances.  They are broader based hence may be easier to manage than Calendars and Double Calendars.  You can also introduce a up/down bias in buying more / less back month options.
  • More radical variant: the short calendar, i.e. buying the front month.  Careful though as margin is LARGE on a Reg T account.  This strategy is not covered by Options Masters, but it is up to the OM community to debate about it !
  • Typical adjustment:  if it goes seriously wrong early on the trade (1st day on shorts) either take off the spread, and reposition, otherwise contemplate a double calendar i.e. add one on new strike level that cuts Delta by 2/3 to 3/4.  Of course, double also means higher margin (Reg T) unless you already have a position that you can split for an adjustment (recommended if margin is an issue).
double calendar spread
Double Calendar

So what do you get when you enter a typical Calendar (ATM):

  • Zero Delta
  • Zero Gamma
  • And Vega / Theta ratio = 1-2 for weeklies, and 6 to 8 for monthlies

Other sources of information

Finally, here is some additional info from other sources: MoneyShowOptionsMonster and the introductory YouTube videos from Sheridan Mentoring below.  Also, for a good reminder on which options strategies to follow according to some parameters, check for instance the Options Guide or OptionIQ.


Calendar Videos

Double Diagonals

 

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