Call Calendar Spread

Call Calendar Spread overview

Call calendar spreads consist of two call options. A short call option is sold, and a long call option is purchased at the same strike price but with a later expiration date than the short call. A call calendar spread looks to capitalize on minimal price movement and time decay in the near-term call option and rising volatility in the long-term call option. The strategy is successful if the underlying stock price stays at or below the short call before the front-month expiration, then moves up beyond the back-month long call option, preferably with increasing volatility. A debit will be paid to enter the position because the longer-dated options will be more expensive. The initial cost to enter the trade is the maximum loss at the front-month expiration.

Call Calendar Spread market outlook

A call calendar spread is purchased when an investor believes the stock price will be neutral or slightly bearish short-term. The position would then benefit from an increase in price after the short-term contract expires and before the longer-dated contract is closed. The position has a maximum loss defined by the cost to enter the trade. If the underlying stock price is above the short call at expiration, the long call may be exercised to cancel out the assignment of the short shares. The position would then be closed for a max loss.

Ideally, the stock price is at or just below the short call at the time of expiration, and the short contract would expire worthless. A decision will then need to be made to either exit the long call position or wait to see if the stock price and/or implied volatility increases before the second expiration date. The further out-of-the-money the strike prices are at trade entry, the more bullish the outlook on the underlying security.

How to set up a Call Calendar Spread

A call calendar spread is created by selling-to-open (STO) a short-term call option and buying-to-open (BTO) a call option with a later expiration date. Both call options will have the same strike price. Long call calendar spreads will require paying a debit at entry.

The initial cost is the maximum risk for the trade if the short call option is in-the-money and/or both options are closed at the front-month expiration. The profit potential is unlimited if the short call expires worthless, and the underlying stock price and/or implied volatility has a significant increase.

Call Calendar Spread payoff diagram

The payoff diagram for a call calendar spread is variable and has many different outcomes depending on when the options trader decides to exit the position. The maximum risk is defined at entry by the debit paid to enter the spread, if both options are exited at the first expiration.

If the stock price is above the short call options’ strike at the front-month expiration and the investor chooses to close both options, the loss would be the trade’s initial cost. If the stock price is below the short call strike at expiration--which is the goal of the calendar spread--the short contract will expire worthless. The long call option will still have extrinsic time value remaining. The investor can choose to exit the long call at this point or continue to hold the position with no increased risk.

At the near-term expiration the payoff diagram slightly resembles an inverted V. After the near-term expiration, if the long call option is held, the payoff diagram is the same as a long call. If the stock price and/or implied volatility increases before the long call’s expiration date, the position will gain value. If the stock price drops, the extrinsic value of the long call will decrease.

For example, if a stock is trading at or below $50, and an investor believes the stock will stay below $50 before the first expiration, a call calendar spread could be entered by selling a $50 call option and purchasing a $50 call option with a later expiration date. Assume the short call was sold for $2.00 and the long call was purchased for $4.00. The initial debit of -$2.00 would be the maximum loss at the first expiration if both options are closed. If the short call is out-of-the-money at expiration, it will expire worthless, and the long call could be sold for its extrinsic value. The payoff diagram below illustrates a $100 profit as the outcome with the underlying stock trading at-the-money at the first expiration if the long call is sold with $3.00 of extrinsic value remaining.

However, the long call’s value may increase or decrease after the first expiration, depending on the price movement of the underlying security. If the short call is in-the-money at the first expiration and the long call is not sold simultaneously, the maximum risk may exceed -$200 if the stock subsequently reverses before the second expiration.

Entering a Call Calendar Spread

A call calendar spread consists of selling-to-open (STO) a short call option and buying-to-open (BTO) a long call option at the same strike price, but with a later expiration date.

For example, suppose a stock is trading at or below $50, and an investor believes the stock will stay below $50 in the near future. In that case, a call calendar spread could be entered by selling a short-term $50 call option and purchasing a $50 call option with a later expiration date. The long call contract will have a higher premium because it has more extrinsic time value, so the position will cost money to enter. The debit paid will be the maximum risk for the trade at the expiration of the first contract.

The farther out-of-the-money the strike prices are at trade entry, the more bullish the outlook on the underlying’s price.

Exiting a Call Calendar Spread

The decision to exit a call calendar spread will depend on the underlying asset’s price at the expiration of the short call contract. If the stock price is below the short call, the option will expire worthless. The long call option will be out-of-the-money and have time value remaining. The extrinsic time value will depend on the length of time until expiration and the strike price relative to the stock price.

Time value, or theta, works against the long option, and the contract will lose value exponentially as it approaches expiration. A sell-to-close (STC) order will be entered when the investor wishes to exit the position. The credit received when selling the long option, minus the original debit paid, will result in a profit or loss. If the underlying stock price is above the short call at the first expiration date, both options may be closed to exit the position. This will result in the maximum loss on the trade.

If the investor chooses only to close the in-the-money short call option, there is potential for more risk. The stock could reverse, and the long call option will lose value. However, if the stock price were to increase, a larger profit could still be realized. Legging out of a call calendar spread can increase the risk beyond the initial debit paid, but creates the highest profit potential.

Time decay impact on a Call Calendar Spread

Time decay will positively impact the front-month short call option and negatively impact the back-month long call option of a call calendar spread. Typically, the goal is for the short call option to expire out-of-the-money. If the stock price is below the short call at expiration, the contract will expire worthless. The passage of time will help reduce the full value of the short call option prior to expiration.

The time decay impact on the back-month option is not as significant early in the trade, but the theta value will increase rapidly as the second expiration approaches. This may influence the decision related to exiting the position.

Implied volatility impact on a Call Calendar Spread

Implied volatility has a mixed effect on call calendar spreads. Generally, call calendar spreads benefit from an increase in implied volatility. Ideally, the front-month short call option will expire out-of-the-money and be unaffected by changes in implied volatility. The position will experience the most profit if volatility is higher at the time of the second expiration. However, the stock price will need to be below the options’ strike price at the first expiration for the call calendar spread to be successful.

If implied volatility increases significantly early in the near-term expiration, the spread between the two contracts will decline. After the near-term expiration, the more implied volatility, the better. Higher implied volatility means there is a greater expectation of a large price change which is ideal for the remaining long call position. Future volatility, or vega, is uncertain and unpredictable. Still, it is good to know how volatility will affect the pricing of the options contracts.

Adjusting a Call Calendar Spread

Call calendar spreads can be adjusted during the trade to increase credit. If the underlying stock price declines rapidly before the first expiration date, the short call option can be purchased and sold at a lower strike closer to the stock price to receive additional credit.

For example, if a call calendar spread was entered at $50, and the underlying stock has dropped to $40 before the first expiration, the short call could be bought back and resold at $45. This will collect more premium to help offset the initial debit paid, but if the stock reverses, the risk will increase to at least $5.00, the adjusted spread width between the strikes of the near-term expiration contract and long-term expiration contract.

If the underlying stock fails to challenge the strike price before expiration, the spread value has typically widened, allowing the position to be closed for a small profit, and no adjustment is necessary.

Rolling a Call Calendar Spread

The short call option of a call calendar spread can be rolled lower if the underlying stock price drops. The short call may be purchased and resold at a lower strike price to collect more credit and increase profit potential. Ideally, the stock still closes below the short option, so it expires worthless. The long call option may have extrinsic value remaining to help reduce the loss or potentially make a profit.

Hedging a Call Calendar Spread

Call calendar spreads are not typically hedged. The strategy has a specific goal and defined risk. The position can be adjusted lower if the underlying stock price drops. The call calendar spread holder may do nothing and continue to hold the position, allowing the near-term contract to expire worthless, and see if the underlying security recovers during the longer-term expiration.