Calendar spread

In finance, a calendar spread (also called a time spread or horizontal spread) is a spread trade involving the simultaneous purchase of futures or options expiring on a particular date and the sale of the same instrument expiring on another date. The legs of the spread vary only in expiration date; they are based on the same underlying market and strike price.

The usual case involves the purchase of futures or options expiring in a more distant month and the sale of futures or options in a more nearby month.

The calendar spread can be used to attempt to take advantage of a difference in the implied volatilities between two different months' options. The trader will ordinarily implement this strategy when the options he is buying have a distinctly lower implied volatility than the options he is writing (selling).

In the typical version of this strategy, a rise in the overall implied volatility of a market's options during the trade will tend very strongly to be to the trader's advantage, and a decline in implied volatility will tend strongly to work to the trader's disadvantage.

If the trader instead buys a nearby month's options in some underlying market and sells that same underlying market's further-out options of the same striking price, this is known as a reverse calendar spread. This strategy will tend strongly to benefit from a decline in the overall implied volatility of that market's options over time.

When market conditions crumble, options become a valuable tool to investors. While many investors tremble at the mention of the word "options", there are many option strategies that can be used to help reduce the risk of market volatility. In this article we are going to examine the many uses of the calendar spread.

Futures calendar spreads or switches represent simultaneous purchase and sales in different delivery months, and are quoted as the difference in prices. If gold for August delivery is bid $1601.20 asking $1601.30, and gold for October delivery is bid $1603.20 asking $1603.30, then the calendar spread would be bid -$2.10 asking -$1.90 for August–October.

Calendar spreads or switches are most often used in the futures markets to 'roll over' a position for delivery from one month into another month.

When trading a calendar spread, try to think of this strategy as a covered call. The only difference is that you do not own the underlying stock, but you do own the right to purchase it. By treating this trade like a covered call, it will help you pick expiration months quickly. When selecting the expiration date of the long option, it is wise to go at least two to three months out. This will depend largely on your forecast. However, when selecting the short strike, it is a good practice to always sell the shortest dated option available. These options lose value the fastest, and can be rolled out month-to-month over the life of the trade.

...
Wikipedia