11 Minute Read

Options Theory: Meet the Calendar Spread

August 16, 2018

By | 4 Comments

Pro Members have exclusive access to 31 powerful trading strategies categorized according to the Options Greeks. Bullish, bearish or neutral market conditions, this Playbook will help you trade with greater confidence.

Last update: July 2021

Think about the everyday cash flow trader’s toolbox. What are his top five strategies? If you answered covered calls, naked puts, bull puts, bear calls, and iron condors, then pat yourself on the back. You’re officially well versed in the option selling business. Do you know what each one of these has in common?

They’re positive theta.

Duh. That’s the easy one. All cash flow trades profit from time decay. What else do they have in common?

They’re all negative vega.

That’s pro speak for short volatility which means they profit from a drop in implied volatility (IV). And since IV is mean-reverting it’s most likely to drop when it is high.

So the top five cash flow strategies are all more attractive in high IV environments. As a side note, I use the mighty implied volatility rank  indicator and would consider anything with an IV rank above 50% as “high.”

And now we arrive at the tantalizing question for today’s post.

What does a cash flow trader do in low IV environments?

I have two answers.

First. Don’t change anything. Keep doing your typical strategies and simply accept the lower premiums that you’re being paid. The market is probably slow-moving and the risk of a big adverse move is diminished so you don’t deserve to be paid as much.

So stop complaining.

Second. Consider cash flow strategies that are more attractive in low IV environments. They are known as calendar spreads.

Calendars involve buying long-term options while selling short-term options. Suppose we have a $200 stock.

A put calendar might consist of buying a two-month $200 put and selling a one-month $200 put. Right now that would be buying Oct and selling Sep.

A call calendar might consist of buying an Oct $200 call while selling a Sep $200 call.

These examples involved buying and selling the same strike and are known as horizontal calendars. Another variation exists where you buy and sell different strikes and is known as a diagonal calendar.

Since long-term options have a higher sensitivity to volatility, the trade is positive vega. This is a key point! You capture positive theta with this type of trade but unlike every other cash flow trade, this one is better suited for low IV environments.

The risk graph of a calendar looks like a tent where the profit zone peaks at the short strike. In the $200 calendars mentioned above we would be shooting for the stock to sit near $200 at expiration. If I thought the $200 stock was going to rise toward $205 then I would want to establish my calendar with the short strike at $205.

This is what the risk graph looks like:

Calendar Risk Graph in Thinkorswim.

If the stock moves outside of the tent then we can widen it! Just add another tentpole like so:

Double Calendar Risk Graph in Thinkorswim.

Mastering the dynamics of a calendar spread is outside the scope of a single blog post, but I wanted to put it on your radar as a topic worth pursuing. I use calendars frequently in low-volatility environments when verticals are no longer appealing.

For example, if a stock is oversold and due to pause for a few weeks I would typically consider entering an iron condor. But if implied volatility is too low then I’ll do calendar spreads instead.

Furthermore, I’ve discovered that slightly OTM put calendars work really well with stocks that are overbought with low implied volatility. Normally that’s a setup I wouldn’t trade.

Learning a new strategy opened me up to adding a new tradable setup to my playbook. That increases the number of trades I can do and thus the money I can make. You’ll see me highlight calendars from time to time in the weekend Options Report (PRO Members Only).

Tackle Trading: Financial Freedom is a Journey. Sign up now for a 15-day free trial.

Financial freedom is a journey

Sign up now and gain unfettered access to all of the quality content and powerful Scouting Reports that our Pro Members enjoy for 15-days absolutely free with no strings attached and let us show you what your trading has been missing.

Legal Disclaimer

Tackle Trading LLC (“Tackle Trading”) is providing this website and any related materials, including newsletters, blog posts, videos, social media postings and any other communications (collectively, the “Materials”) on an “as-is” basis. This means that although Tackle Trading strives to make the information accurate, thorough and current, neither Tackle Trading nor the author(s) of the Materials or the moderators guarantee or warrant the Materials or accept liability for any damage, loss or expense arising from the use of the Materials, whether based in tort, contract, or otherwise. Tackle Trading is providing the Materials for educational purposes only. We are not providing legal, accounting, or financial advisory services, and this is not a solicitation or recommendation to buy or sell any stocks, options, or other financial instruments or investments. Examples that address specific assets, stocks, options or other financial instrument transactions are for illustrative purposes only and are not intended to represent specific trades or transactions that we have conducted. In fact, for the purpose of illustration, we may use examples that are different from or contrary to transactions we have conducted or positions we hold. Furthermore, this website and any information or training herein are not intended as a solicitation for any future relationship, business or otherwise, between the users and the moderators. No express or implied warranties are being made with respect to these services and products. By using the Materials, each user agrees to indemnify and hold Tackle Trading harmless from all losses, expenses and costs, including reasonable attorneys’ fees, arising out of or resulting from user’s use of the Materials. In no event shall Tackle Trading or the author(s) or moderators be liable for any direct, special, consequential or incidental damages arising out of or related to the Materials. If this limitation on damages is not enforceable in some states, the total amount of Tackle Trading’s liability to the user or others shall not exceed the amount paid by the user for such Materials.

All investing and trading in the securities market involves a high degree of risk. Any decisions to place trades in the financial markets, including trading in stocks, options or other financial instruments, is a personal decision that should only be made after conducting thorough independent research, including a personal risk and financial assessment, and prior consultation with the user’s investment, legal, tax and accounting advisers, to determine whether such trading or investment is appropriate for that user.

4 Replies to “Options Theory: Meet the Calendar Spread”

  1. ROBERTMCKEE says:

    Thanks Tyler! Yes it’s been difficult to find good candidates for traditional theta trades with high IV that don’t have earnings on the horizon. My calendar spreads have worked better for me recently and now I know why!

    1. Tyler Craig says:

      Glad to hear it, Robert!

  2. AbidRahnaman says:

    Great read, thanks Tyler!

Comments are closed.

Chart Modal

Tackle Trading

Book a FREE Consultation

Sign up for a free consultation to build your Educational Plan.