Basics of Calendar Spread Trading
Calendar spread trading is helpful for beginners. This trading approach involves purchasing and selling options with the same strike price but different expiration dates. The calendar spread, often called a horizontal spread or time spread, may assist traders profit from time decay.
Understanding Calendar Spread
How does calendar spread work? Calendar spread traders purchase and sell options contracts with longer and shorter expirations. Profit from contract time decay differences.
A trader may foresee a stock’s long-term increase but short-term stability. A calendar spread is done by purchasing a later expiration date call option and selling a closer expiration date call option with the same strike price. Traders may benefit from the shorter-term option’s time decay and the stock price’s long-term growth.
Pros and Cons
Trading beginners profit from calendar spreads. Since options lose value approaching expiration, traders may benefit from time decay. Second, calendar spreads are suitable to low-capital traders because they need less initial capital than other options approaches.
Calendar spreads are risky. Short-term option losses may increase if the stock price changes drastically. If the stock price stagnates or doesn’t meet traders’ expectations, the longer-term option may lose value.
Implementing Calendar Spread
Calendar spread traders must consider various factors. Choices include striking price, expiration dates, and risk-reward ratio.
Consider the stock price and projected price movement while choosing the strike price. Traders frequently choose strike prices above or below stock prices.
Traders choose options contract expiration dates. Shorter-term options should expire sooner, longer-term ones later.
Finally, traders must calculate risk-reward. Calendar spread earnings are limited to the difference between the options’ strike prices less the setup cost. Before trading, compare gains and losses.
Conclusion
Novice traders like the calendar spread for its simplicity and profit possibilities. Traders may benefit from market volatility by analyzing price swings and time decay. As with any trading approach, research the calendar spread’s risks before employing it.
References and sources:
1. Investopedia (2022). Definition of Calendar Spread. See https://www.investopedia.com/terms/c/calendarspread.asp.
2. Fidelity (2022). Strategy for calendar spread options. Retrieved from https://www.fidelity.com/learning-center/investment-products/options/options-strategy-guide/calendar-spread
3. TD Ameritrade (2022). Calendars spread. Trading calendar spreads and options method, https://tickertape.tdameritrade.com/trading/161872.