Calendar Spread Explained
A calendar spread sells a short-dated option and buys a longer-dated one at the same strike, profiting as the front leg decays faster than the back.
What it is
A calendar spread, also called a time or horizontal spread, sells a near-term option and buys a longer-dated option at the same strike. You pay a net debit because the longer-dated option costs more. The trade profits from the fact that the short front-month option decays faster than the long back-month option, so if the underlying sits near the strike as the front expires, you capture the difference in time decay. It is a bet on time and on term structure rather than direction: it wants the underlying calm near the strike in the short run and ideally an increase in longer-dated implied volatility.
Payoff at expiration
When to use it
Use a calendar spread when you expect the underlying to stay near a strike in the near term and you want to be long back-month volatility cheaply. It works best when the volatility term structure is flat or in backwardation so the long back-month leg is not overpriced, and when front-month implied volatility is rich to sell. Traders place calendars at a target strike ahead of a slow-grind period, or straddle an event by putting the short leg in the pre-event expiry to harvest its inflated premium. Avoid it when you expect a large immediate move, which hurts the position on both the direction and the front-leg gamma.
Greeks profile
| Delta | Near zero at entry when placed at-the-money, with a mild directional lean depending on strike choice. |
| Gamma | Short gamma from the near-dated leg dominates, so a large fast move away from the strike hurts. |
| Theta | Positive. The front leg decays faster than the back, and that net positive theta is the engine of the trade. |
| Vega | Long vega. The longer-dated leg carries more vega, so a rise in back-month implied volatility helps the position. |
Max profit, max loss & break-evens
Achieved when the underlying sits at the strike as the front leg expires; the exact amount depends on back-month value at that point. Limited to the net debit paid, approached if the underlying moves far from the strike in either direction. Two break-evens around the strike, whose width depends on the debit and the remaining back-month value (no simple closed form).
Concrete example
A stock trades at 100. You sell the one-month 100 call for 3 and buy the three-month 100 call for 5, a net debit of 2. If the stock is still near 100 when the front call expires worthless, you keep a two-month 100 call that still has substantial value, and you can sell another front-month call against it. If the stock instead jumps to 120 or falls to 80, both legs move together and the spread loses most of the 2 debit.
Risks & management
The maximum loss is the debit, which is defined, but two forces can realise it. A large move in either direction flattens the value difference between the legs and can take most of the debit, and a collapse in back-month implied volatility hurts the long vega leg. The trade also has a moving profit zone that depends on where the underlying sits as the front expires. Manage by closing or rolling the front leg as it decays, taking profit when the underlying is near the strike and the front is nearly worthless, and avoiding calendars into events that can gap the underlying away from the strike.
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