Calendar Spreads Pay Larger Premiums

Calendar spreads are a great modification of the diagonal option spread strategy. The calendar spread is useful when you are more uncertain about the direction of the market and want to increase the effectiveness of the hedge during periods of market volatility. If you are new to this concept, click here for the first article in the series on diagonal spreads or selling covered calls on LEAPS Calendar Spreads.

A calendar spread consists of two options.

• 1. The first option is a long call with a long-term expiration date. Usually traders will use LEAPS or options with expiration dates longer than a year. This is just like the long-term call used in the diagonal spread strategy.
• 2. The second option is a short call with a short-term expiration. That position is also similar to the short call used in the diagonal spread with one difference – it has the same strike price as the long call you purchased. The identical expiration date is what makes this a calendar spread. If you need some help understanding how to sell an option, click here.

The ratio of the premium received from the short call to the price you paid for the long call is much larger than the same ratio in the diagonal spread. However, because the short call has a lower strike price, there are smaller potential profits if the market breaks out to the upside. In the video, I will cover the details of entering a sample options calendar spread.

The larger premium compared to the amount invested in the long call creates a larger hedge against downside movement in the market. If prices drop, the larger premium from the short call will offset more losses than the short call in a diagonal spread.

This is a great way to implement the benefits of a diagonal spread in the market when you are uncertain and not very bullish.

Diagonal spreads and calendar spreads are commonly known as “time spreads” and illustrate just two popular variations of the option spreads concept.

The best way to make sure you are familiar with the trade is to experiment through paper trading. The practice will help you see how prices change as the market moves.

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