Demystifying calendar spread and its types

 

Calendar spread
 
Calendar spread is nothing but selling option in shorter expiration and buying the same strike price option in long expiration at the same time in the same underlying asset. It is also called long calendar spread. It can be created in both call and put side. If it is created in both call and put, it is called double calendar.
 
Example (Long put calendar)
Market spot price is: Nifty 11550 Current Month: Jan 2018
 
Sell Nifty 11500 PE in Jan 2018 @ 150
Buy Nifty 11500 PE in Feb 2018 @ 200
 
Total debit: 50
Max Loss: Total debit paid
 
It is a debit strategy wherein one is trying to exploit the faster time decay in current month. At the same time, same option is purchased in longer expiration for hedging to medicate the unlimited risk. Hence it is a risk defined strategy wherein the loss is limited.
 
Pay-off wise, it may look similar to short strangle, but the loss is limited in calendar spread. Hence is the pay-off of calendar spread
 

 
 
 
 
  
 
 
 
 
Reverse calendar spread

 
The same can be done in reverse way to create reverse calendar spread. This is also called short calendar spread. Generally this is done in call side.
It is nothing but selling option in buying expiration and selling the same strike price option in long expiration at the same time in the same underlying asset. It is also called long calendar spread. It can be created in both call and put side
 
Example (Short call calendar)
Market spot price is: Nifty 11550 Current Month: Jan 2018
 
Buy Nifty 11500 CE in Jan 2018 @ 150
Sell Nifty 11500 CE in Feb 2018 @ 200
 
Total Credit: 50
Max Loss: Total credit paid
 
Pay-off for reverse calendar spread may look like this.
 
 
Put calendar Vs Call Calendar
 
It can be created in both call and put side, however put calendar spread is more famous than call calendar. By theory, all calendar spreads would be used for range-bound view. But in reality, put calendar is used for bullish view.
 
Put calendar types
 
There are different types of put calendars can be created based on view and level one has
1)      OTM put calendar
2)      ITM put calendar
3)      ATM put calendar
4)      ITM put calendar
5)      Near expiry put calendar
6)      Advanced put calendar
7)      Diagonal put calendar
Though we have many varieties in put calendar, mostly reverse call calendar is being used for bearish view.
 
FAQs
 
1)      Is calendar spread better than vertical spread?
 
Yes. It is better because there is a chance that both legs in calendar spread may give profit. It is not possible with vertical spread.
 
2)      Do I need to consider IV when creating calendar spread?
 
Bookish theory says that. It is better to define strategy based on view and break-even. In my experience you can do calendar spread in all IVs
 
3)      Why cannot we get the exact profit and loss of calendar spread?
 
      We cannot know because long option in longer expiration value depends on IV value which we cannot predict.
 
4)      How much volume can I do in calendar spread?
 
10% of your volume you can do at a time.
 
5)      Why only put calendar is very famous than call calendar?
 
True. There are two reasons. I) When market goes down, longer PE option will give better profit, but when market goes up, IV will come down which is not good for long CE option II) When market goes after creating put calendar, one can sell CE to defend it. But if when market goes up in call calendar, one is supposed to sell PE to defend the positions. Selling PE is most vulnerable to black swan event.
 
6)      Is there any margin benefit I will get as the risk is defined?
   
      Technically loss is limited hence margin to be blocked should be less, But NSE charges full margin. There are no margin benefits
 
7)      I created calendar spread. I do not see profit coming to my terminal. Why?
 
Have you noticed correctly? The loss also will not come easily. Calendar spread is boring strategy wherein we are trying to exploit premium melting speed in shorter and longer expiration.
 
8)      Break-even for calendar spread seems to be very scary to me. Why?
 
100% true. A plain vanilla calendar spread break-even should be scary to new trader. However if you do more adjustments, you can change break-evens dynamically.
 
9)      How to do adjustment in calendar spread?
 
Please watch Traders Carnival Video wherein I clearly talked about put calendar and its adjustments
 
 
10)  Can I adjust put calendar with call calendar if view goes against my view?
 
      This is what being recommended. But I do not recommend. It is better adjustment the existing strategy than creating calendar spread in opposite strategy.
 
11)  Will it work in Nifty or Banknifty?
 
      Calendar spread planned for short term will suit for Banknifty. Nifty will suit for calendar which is planned for longer time.
 
12)  What is the use of reverse calendar spread?
 
I do not use it much. Instead, I prefer to sell naked call option.

Jegathesan Durairaj, a mathematician by qualification, an Ex-software professional and now a full time Risk Defined Option Writer. With his Open Book Strategies, he is the most known identity in twitter as itjegan, with huge followers. He had won Zerodha 60 Day Challenge – 10 Times round-the-clock. He is one of the prime Option Writing Trainer and tutored close to 1000 members till now.

He is the Mastermind of CapitalZone РActive Option Trading where Traders can avail Trading Chart with customised indicators, FNO tools and Payoff analysis. His keynote is to provide whole FNO deets to be handy for Traders in a sole place.

Now he is taking more heed on hedging portfolio in Option Writing where we might subject to more market risk. He is streamlining his strategies often and improving perpetually. At this time unfolding ways to measure good-quality Trend Following System.

Conducting workshop in all Metro Cities (Delhi, Mumbai, Bangalore, Chennai and Coimbatore) often based on queries from Traders.

 

 

10 comments found

  1. Thanks for posting this, very helpful for novice traders like me.
    I have been trying to understand Why When IV of long position goes down break even shrinks and vice versa??? Any idea???

  2. You said, max loss is total debit paid on put calender spread example!! Where as the pay off chart shows max loss is unlimited after breakeven range

  3. Hi Jegan, long put calendar is for bullish view. does going long with current month Put and going short on next month expiry put performs well neutral to bearish market?

  4. how in your experience “what is near expiry put calender spread” how it can be done i mean itm or otm pe. can u elaborate pls????

  5. Thank you for this wonderful post. I have a query regarding intraday margins we get for selling options. Lets say we trade using exposure margin on expiry day and do all the adjustments, since positions have to be closed before 3.15/3.10, we cannot make any adjustments after that right? If you have to do breakeven adjustments after 3.10 for firefighting, how do you do?

    1. Your broker should allow to do upto 3.30.
      If need any broker assistance, please reach us +91 9962143422

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