One of the more recent additions to my strategy playbook is the put calendar spread. The reason for adding it to my bag of tricks was simple. It allowed me to exploit a new trade setup that I previously wasn’t able to.

Take a look at the chart of Costco for a second and tell me what strategy you would usually use to play the chart here.

COST stock is overbought and has an extremely low implied volatility reading. Normally I’d pass on a chart like this. It’s too late to buy but too strong to short. You wait for a pullback, then probably deploy something like a bull call spread to capitalize on the underpriced options.

But this is where the put calendar spread comes in. It works perfect for overbought stocks carrying low IV because it gets you positive vega and builds a profit zone that will deliver the goods if the stock pulls back, pauses, or maybe even rises slightly. And if it moves up too much, I could adjust the trade to shift the profit zone higher.

The structure of the trade is to buy a 2- or 3-month slightly OTM put and sell a 1-month put of the same strike against it. This is also known as a horizontal spread.

With COST at $282, I could enter an Aug/Oct $275 put calendar for around $4.65. Here is the initial risk graph. I’ll also include a price chart with lines drawn at the breakeven levels.

Per the chart, the trade flourishes if COST stagnates or retreats slightly over the coming weeks. I’m profiting from time decay along the way and if implied volatility jumps, then the gains will really take flight. In greek speak, I’m negative delta, positive theta, and positive vega.

But I’m not going for a big target here. Anything around a 15% to 20% return will do. After all, this is sort of a counter-trend trade. COST is in an uptrend and I’m deploying a bearish leaning position. Essentially, I’m banking on a pullback materializing sometime over the next week or two, as well as a rebound in implied volatility. Once that happens, I’ll take profits swiftly so that I don’t give it all back if the dip bets bought and a new upswing takes root.

If we paid $4.65 for the spread then a 15% gain would peg my exit at $5.35. A 20% return would put me at $5.58.

The Upside Adjustment

But what if COST keeps powering higher? What if its gravity defiance persists? Well, in that case I might add a 2nd put calendar to morph my position into a double put calendar. I could layer in the second tier using a higher strike price, such as $280.

The net effect on my risk graph is to shift the profit zone higher thereby increasing my odds of success. I’m widening the profit tent so that COST doesn’t have to pull back as far when sellers finally strike.

You could even do this a third time if the rally gets really long in the tooth. That turns this into a triple calendar. You’ll see the impact in the graph below.

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