Calendar Put Spread

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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 options 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. 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 within a tight price range while keeping a long term put options position for when the stock breaks out to downside in future.



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) LEAPS 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.


Read the full tutorial on Diagonal Calendar Put Spread.

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.


Read the full tutorial on Horizontal Calendar Put Spread.



Trading Level Required For Calendar Put Spread


A Level 3 options trading account that allows the execution of debit spreads is needed for the Calendar Put Spread. Read more about Options Account Trading Levels.



Profit Potential of Calendar Put Spread :


Both the Diagonal Calendar Put Spread and the Horizontal Calendar Put Spread makes their maximum profit when the underlying stock closes at the strike price of the short put options during expiration of the short put options.

Profit Calculation of Calendar Put Spread:


The value of a Put Time Spread during expiration of the short put options can only be arrived at using an options pricing model such as the Black-Scholes Model because the expiration value of the long term put options can only be arrived at using such a model.



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 rises or falls strongly and can only be calculated using the Black-Scholes model.



Advantages Of Calendar Put Spread:



  • Able to profit even if underlying asset stays stagnant.

  • 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.



    Adjustments 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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