The Best Way to Utilize Calendar Spreads

The calendar spreads profits those that are seeking to profit from stocks and sideways markets. Those that take advantage of different implied volatility and time decay in different expiration months. Many investors are afraid every time they hear the word options, but the option is valuable when the market conditions crumble. Many available option strategies help in reducing the market volatility risk. A calendar spread is one of the methods that investors can use during any market climate.

What Are Calendar Spreads?

According to tastytrade, “A Calendar Spread is a low-risk, directionally neutral strategy that profits from the passage of time and/or an increase in implied volatility.”

It is a strategy used by those who buy longer-term options and sell an equal number of short-term options of the same underlying index or stock with the same strike market. They can either be done, and it is an excellent way of combining the advantages of directional options and spreads in one position.

The investor, in this case, assumes the position of a neutral market position that, if rolled out several times, takes advantage of the time decay and pays the cost of the spread. They can also take the position of a short-term market-neutral; this position has a limited gain potential but has a longer-term directional bias. In either of those options, a trader can provide many advantages compared to put and plain old calls.

Rules for Trading

  • Always have an exit plan even before beginning a trade,
  • Before placing the trade, always check the P/L graph, and do not trade through dividends date or essential news like the earning announcements.
  • Trade only those stocks that have positive volatility or are in the range
  • The front-month options should take 5-7 weeks to expire,
  • Use puts to place the trades because it’s cheaper than the calls.

Planning the Trade

The first step to planning a trade is forecasting the market conditions and identifying the market sentiments over a few months. If the market outlook is bearish, the market sentiments don’t seem to change in the next few months; then the investor can consider a put calendar spread.

This kind of strategy applies to exchange-traded funds, indexes, and stocks, considering a liquid vehicle with narrow spreads that are between the ask and bid prices.

The trader or investor must establish an exit plan and manage the risks in the best way possible; proper positions help manage the risk. The risks include limited upside during the early stages, expiration dates, and untimely entry.

It’s also vital that the trader considers a covered call strategy while trading a calendar spread by picking expiration months depending on the forecast.

A long calendar spread is best used when the trader expects the price to almost be the same as the strike price when the front-month option expires. A calendar spread will earn you money through time decay. There is also money found when the volatility for the far month option increases and the short-term options volatility decreases. Due to this volatility, the option gains more value and is worth more money. However, managing the position is paramount.

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