CALENDAR SPREAD... The basics

You have probably been introduced to calendars as sideways strategies. You can use Optionetics' Platinum to select stocks that have a limited "giration". In my mind Calendar spreading is a very stressfull strategy because you don't really know when a stock is going to JUMP out of your up and donw breakeven points. I have tried too many of these, and I spent too many sleepless nights and in the end I did not make much money. The best way to describe a calendar spread based on sideways motion is, as I like to say: Like watching grass grow worrying that your dog may pee on it.

There is a place for calendar spreads, though, and it is quite limited, in my way of thinking, and it is to take advantage of volatility skews. It is true that back month options (anywhere between Aug to Jan and beyond), may often be less susceptible to time decay. Front month options decline in price as expiration approaches. The effect of time on the price of an option is called THETA, and the effect is called Theta decay.

I WOULD use calendars when there is a “volatility skew”. Meaning, that the front month has an increase in demand (because of some news item). Implied volatility is what determines the price of an option. There are mathematical models that quantify this I.V. and the number thus calculated is called VEGA. If Vega is high for the front month option, and low for the back month option, you have a Volatility skew. A calendar spread may be designed to take advantage of a temporary situation but you MUST get out of the trade as soon as volatility in the front month has declined. You could rollover the option to the second month, if there is a volatility skew between second month and back month options. The difference in volatility between front month and second month must be there to make it worth you while. Keep an eye on volatility, and you make money. Ignore volatility, and a strong spike will make you the victim of a volatility crush.

Calendars are high risk, low reward in my mind simply because any stock can jump strongly in either direction in unpredictable ways. Nevertheless, I do use the philosophy described here. My approach is a Straddle Calendar. That is, I buy calls and puts for the back month, and sell 1/2 the number of calls and puts of the front month, all at the same strike price. Some may think that this is crazy because all legs of the position may appear to cancel each other. This would be true if one was to ignore Vega and the potential a stock has to move in either direction in the long run. As you could see for the real trades I have shown here, I rarely fail to make money using this strategy. A more generic term of the Straddle Calendar that includes the Strangle calendar is the name is the Put Call Calendar Ratio Combination or "PCCRC" for short.

This strategy would take advantage of the sideways movement of stocks with volatility skews, but I feel protected by the back-month options, in case there is a violent move in either direction. I can also rollover the shorts month after month, until the violent move does occur or a volatility spike increases the price of my long options (remember, I own 2x as many as I short).

Calendars and such strategies are advanced strategies and require a working knowledge of the GREEKS. Brokers such as OptionXPress and Interactive brokers DO show you the Greeks for each individual option so you can make judgments.