Ultimate Guide To Trading Call Calendar Spreads - YouTube

Hey everyone.

This is Kirk, here again at optionalpha.com where we show you how to make smarter trades.

In today's video, we’re going to go over the specifics of trading a call calendar spread.

A long call calendar spread profits from a slightly higher move up in the underlying

stock inside of a given range, but they also profit from a rise in implied volatility and

therefore, are a great low cost way of taking advantage of low implied volatility markets

and options.

We often trade these when implied volatility has dropped and sometimes, they’re really

good in bullish markets.

As stocks are slowly starting to rally higher, you want to trade either directionally spreads

or trade some of these calendar spreads.

This is exactly how you setup this strategy.

First, you're going to sell a front month out of the money call option.

This is the key point here.

We’re going to sell that front month out of the money call option, that front month

option is going to be a little bit closer to where the market is trading, so days out

is probably anywhere between 20 and maybe 35 days out, then what you’re going to do

is you’re going to buy a more expensive back month option, so the next monthly option

that’s out, an out of the money call spread at the exact same strike price.

We’re going to be trading two different months, but pinning the exact same strike

price.

What's the risk?

Your risk in these calendar spreads is limited to the width of the net debit paid for the

spread.

If you paid a debit of $150 for your calendar, your risk is limited to just that $150, you

can’t lose any more money than that.

Let’s talk about profit potential.

It can be very hard with these strategies because of the decay in the back month option

that you’re long to pinpoint an exact probability of profit.

Ideally, what you’re looking for though is to target your profit at the value of the

sold front month contract.

If you sold the front month contract for $50 and you bought the back month contract for

$150, you’re looking to profit somewhere around $50 or that decay in the value of that

front month contract.

Profit is going to be maximized if the stock settles at the strike price at expiration

because if that happens, then your short strike is completely going to expire worthless and

you’re going to be left with as much extrinsic value left in the long option for the back

month as possible.

That’s the ideal situation.

That's where this profit and loss diagram peaks, is right at your strike prices.

Volatility like we said, an increase in volatility will help this position because we’re going

to be net long options, we’re going to have a longer term option in the back month and

compare to the negative impact on the front month option we’re short, we’re going

to see a greater impact in volatility on the value of that back month option.

That’s why volatility is really good for these positions.

That’s also why you want to trade them first when implied volatility is low because if

you trade these positions when implied volatility is high, you’re putting yourself at a disadvantage

right off the bat because an increase in volatility is going to help and if implied volatility

is already high, then you’re really stacking the deck against yourself.

Time decay is definitely going to help this position because we’re looking to collect

the value of that front month option that we sold.

As an option seller, we like to see time decay and Theta decay start to slowly eat away or

erode that position much faster.

The closer we get to expiration, the faster that profit will start to materialize.

With calendars, breakeven points are so hard to calculate because there’s no single calculation

we can use.

It’s just important that you analyze the trade first before placing an order.

We will actually analyze a trade right here on our Thinkorswim platform.

For this video tutorial, what we’re going to do is we’re going to use the SPY which

is the S&P 500 ETF.

It’s currently trading at just over 23 and we’re going to do a calendar between March

and April.

In this case, the March options which have about 58 days to go here (and we’ll just

going to use a calendar that’s a little bit further out) and those are going to be

our front month contracts.

In most cases, we might actually look to do something a little bit closer, but for the

purposes of this video, I wanted to do something that has really good profit and loss diagram.

The back month contracts in this case are going to be the April contracts which are

about 86 days out.

You can see the front month are March and the back month are going to be April.

In this case, what we want to do is we want to start by selecting a strike price that’s

just a couple of strikes out of the money.

In this case, we’ll go with the 205 strikes in both months, so we're going to target the

205 calls in both months.

What we’re going to do is we’re going to first sell that front month contract.

We’re going to go up here to the option chain and just click on the bid to sell that

front month option at 205.

At the exact same time, what we’re going to do is also buy the 205 call for April.

Now down below, that creates our calendar spread and you can see here below this is

our calendar spread, the April/March calendar and the difference between buying the back

month and selling the front month which are these two prices right here is our net debit

that we pay on this trade of about $.97 or $97.

In this case, the most that we can lose on this trade is $97.

When we look at the profit and loss diagram, you can see that it's got the very familiar

shape that we had in the video and the slides before.

It’s got that high peak that rallies up to 205 and that's the point at which we make

most of our money and then from there, it starts to slowly decline on either end.

But the key here is you don't lose any more than $97 regardless of where the stock goes.

But this profit window for this calendar that we created is very large.

In this case, we can make money all the way from 198 all the way up to about 212 on SPY.

SPY is currently trading about 203, so we’re playing this a little bit directionally bullish,

that’s why we’re doing the call calendar, we ideally like to see the stock rally a little

bit, but in this case, we also leave ourselves an opportunity to make some money even if

the stock drops in value.

That’s why these are slightly directional trades, but if you set them up correctly,

you end up giving yourself an opportunity to make money in both directions of where

the stock might move in the future.

Some of the key takeaways for calendar spreads are that they’re low implied volatility

strategies.

They work best in markets that are low implied volatility that could see a rise in implied

volatility and using these strategies one to two levels out of the money with your strike

prices in the direction that you want to trade.

In the example we just went through with SPY, the stock was trading at about 203 and we

traded the 205s, so we were just about two strike prices out.

You don’t want to get any further than that and you’re going to play it very, very directionally

and not going to take advantage of what a calendar really can do.

We always suggest closing the spread completely both months when you reach that front month

expiration whenever possible.

The reason that you’re going to do that is because you want to maximize that time

decay in the front month contract.

Going back to the spread that we had traded in SPY, because we sold this option for about

3.95, that's ideally the most that we would ever look to make on this trade, but in our

case, we might look to take maybe about a doubling in our premium as far as a profit.

If we could increase our premium 100%, we would take that as far as a profit.

As always, I hope you guys enjoy these videos.

If you have any comments or questions, please ask them right below in the lesson page.

Until next time, happy trading!