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Calendar Put Spread - Introduction
The Calendar Put Spread, being one of the three popular forms of Calendar Spreads (the other 2 being the Calendar Call Spread and Ratio Calendar Spread), is a neutral / bearish strategy that profits when the underlying asset stays stagnant or goes down slightly.
Unlike the Calendar Call Spread, Calendar Put Spreads uses put options instead of call options.
A Calendar Put Spread profits primarily from the difference in rate of premium decay between the near term short options and the long term LEAPs.
This is possible because near term option premiums decay faster than long term option premiums.
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Because you need to buy LEAPs which are more expensive than the short term options that you will write, this strategy results in a net debit and is therefore a form of Debit Spread.
There are 2 ways to establish a Calendar Put Spread. One way is to buy and write options of different expiration months and different strike prices. In this case, it is classified as a Diagonal Spread or Time Spread.
The other way is to buy and write options of different expiration months but at the same strike price. In this case, it is classified as a Horizontal Spread. We will be exploring both versions of
the Calendar Put Spread here. I call them the Diagonal Calendar Put Spread and the Horizontal Calendar Put Spread.
(These classifications are only for a deeper understanding of the kinds of option spread strategies and is not necessary for the execution of these strategies.)
When To Use Calendar Put Spread?
One should use a Calendar Put Spread when one wishes to profit from an underlying asset that is expected to stay stagnant or with slight bearish inclination.
How To Use Calendar Put Spread?
Diagonal Calendar Put Spread
In this version of the Calendar Put Spread, all you have to do is to purchase an In the Money (ITM) LEAP and then sell At the Money (ATM) or Out of the Money (OTM) near term Puts against the LEAP.
Example : Assuming QQQQ trading at $45 now. Buy To Open 10 contracts of QQQQ Jan 2008 $46 Put options at $5.70.
Sell To Open 10 contracts of QQQQ Jan 2007 $45 Put at $0.75.
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We use In The Money (ITM) LEAPs instead of At The Money (ATM) or Out of The Money (OTM) ones so that the Delta value (read about what Option Delta and other option greeks are.)
of the LEAPs are higher than the Delta value of the short term options. This is to ensure that the LEAPs rise in value faster than the short term Puts should the underlying asset drop in price drastically.
Horizontal Calendar Put Spread
In this version of the Calendar Put Spread, you will purchase At The Money (ATM) LEAP Put options and then sell ATM near term Puts against the LEAP Put options.
Example : Assuming QQQQ trading at $45 now. Buy To Open 10 contracts of QQQQ Jan 2008 $45 Put options at $4.70.
Sell To Open 10 contracts of QQQQ Jan 2007 $45 Put at $0.75.
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The ATM LEAP options in this case are cheaper than the ITM LEAP options in the Diagonal Calendar Put Spread and therefore allows you to Put on more positions and also
attain a higher % profit than the Diagonal Calendar Put Spread. The drawback is that you are taking more risk should the underlying asset
drop in price drastically. In this case, as the near time short Put options have a higher delta value than the ATM LEAP Put options, you will lose money on the
short term Put options faster than you will make money on the gain in the LEAP Put options. This makes it more dangerous than a diagonal Calendar Put Spread
and should only be applied on underlying assets that are confident of staying stagnant or very near stagnant.
Profit Potential of Calendar Put Spread :
Diagonal Calendar Put Spread
When the underlying asset
closes at or slightly higher than the strike price of the short Put options, the short Put options
expires out of the money so you make the full value of the short Put options in profits. When the underlying asset is lower than the strike price
of the short Put options upon expiration, the LEAP Put options increase in price faster than the short Put options due to a higher delta value, thus resulting in a net profit.
The Diagonal Calendar Put Spread's maximum profit occurs when the underlying asset closes exactly at the strike price of the short Put options upon expiration of the short Put options.
From the above example : Assuming QQQQ close at $45 on the third Friday (option expiration day) of Jan 2007.
You will make the $750 value of the 10 Jan 2007 $45 Put options that you wrote as they expire out of the money, less,
the decay of the 10 contracts of Jan 2008 $46 Put options.
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Horizontal Calendar Put Spread
A Horizontal Calendar Put Spread profits when the underlying asset closes at or slightly below the strike price of the short Put options. The difference between
this and the Diagonal Calendar Put Spread above is that the latter is able to profit even when the underlying asset moves much lower than the
strike price of the short Put options as the long Put options has a greater delta value than the short Put options. Unlike the Diagonal Calendar Put Spread, should the
underlying asset drop in price drastically, a Horizontal Calendar Put Spread would result in a loss.
Similar to the Diagonal Calendar Put Spread, the Horizontal
Calendar Put Spread's maximum profit occurs when the underlying asset closes exactly at the strike price of the short Put options upon expiration of the short Put options.
From the above example : Assuming QQQQ close at $45 on the third Friday (option expiration day) of Jan 2007.
You will make the $750 value of the 10 Jan 2007 $45 Put options that you wrote as they expire out of the money, less,
the decay of the 10 contracts of Jan 2008 $45 Put options.
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Profit Calculation of Calendar Put Spread:
Diagonal Calendar Put Spread
Profit = Long Put Value at expiration of short term Put options - Net Debit
From the above example : Assuming QQQQ close at $45 as mentioned above
and QQQQ Jan 2008 $46 Put Options are trading at $5.60 then.
Profit = $5600 - $4950 = $650
Profit % = $650 / $4950 = 13.13%
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Horizontal Calendar Put Spread
Profit = Long Put Value at expiration of short term Put options - Net Debit
From the above example : Assuming QQQQ close at $45 as mentioned above
and QQQQ Jan 2008 $45 Put Options are trading at $4.60 then.
Profit = $4600 - $3850 = $750
Profit % = $750 / $3850 = 19.48%
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As we can see from the above, the Horizontal Calendar Put Spread yields a higher profit with a higher risk of loss and the Diagonal Calendar
Put Spread yields a lower profit with a lower risk of loss. Such is the way option trading works, profits are always proportionate to
the risk of loss.
Risk / Reward of Calendar Put Spread:
Upside Maximum Profit: Limited
Maximum Loss: Limited
(limited to net debit paid)
Break Even Point of Calendar Put Spread:
The breakeven point of a Calendar Put Spread is the point below which the position will start to lose money if the underlying asset falls.
Break Even = Stock Price when long Put value is equal to net debit
The long Put value at different prices can only be calculated using the Black-Scholes model.
Advantages Of Calendar Put Spread:
Able to profit even if underlying asset stays stagnant.
Able to offset losses if underlying asset rises in value.
If an investor purchases the Long Put several months out in time, near term Puts can be written several times before the Long Put expiration. Therefore, the cost of the Long Put can be greatly reduced with many writes.
Losses are limited to the net debit.
Disadvantages Of Calendar Put Spread:
Profits are limited even if the underlying asset rallies.
Losses can be sustained if the short Put options are assigned when the underlying asset drops quickly.
Alternate Actions for Calendar Put Spreads Before Expiration :
1. If you wish to profit from a drop in the underlying asset, you could buy back
the short Put options before it expires and allow the LEAP Put Options to continue its profit run.
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