Calendar Spreads: Profiting from Different Decay Speeds

Sell near, buy far, earn the time difference

Calendar spread: sell a 30-day option and buy a 90-day option at the same strike. The near month's time value melts fast and the far month's melts slowly; that difference in speed is your source of profit (the combined Theta is positive).

The P&L looks like a tent

If the stock is right at the strike when the near month expires, the near month goes to zero while the far month is still worth a lot: maximum profit. If the stock runs far away, both legs keep only a little time value, and the most you can lose is the net cost to open.

It's also betting on rising IV

The far month is more sensitive to volatility, so the combined Vega is positive: when implied volatility rises, the whole tent lifts; when IV falls, it drags profits down. It fits a view of “sideways in the near term, IV on the low side”.

Key takeaways

• Calendar spread = sell the near month + buy the far month (same strike). The net cost to open is the maximum loss.
• Positive Theta: the near month decays faster, and the gain is biggest when the stock stays near the strike.
• Positive Vega: the far month is more sensitive to IV, so rising IV helps and falling IV hurts.
• It suits a "sideways in the short term, IV on the low side" view. If the stock runs far away, both legs' time value disappears.

Try it yourself

You can do these exercises in this lesson's interactive simulation:

1. Keep the defaults (strike $100, IV 30%, near month expiring, stock at $100): how much did opening cost? How much are you making now?
2. Drag the stock to $90 and $115: how much do you lose? Is it more than the net cost to open?
3. Set “IV change” to +5 points and −5 points: what does the P&L at a $100 stock price become in each case? Use Vega to explain the difference.
4. Drag “Elapsed” back to 15 days: how much lower is the dashed line (15 days in) than the tent at expiration? How does time make you money?

Quiz and explanations

1. Where does a calendar spread's profit mainly come from?

Answer: The near-month option decaying faster than the far-month one.You sell the fast-decaying near month and buy the slow-decaying far month, so you profit as time passes, as long as the stock doesn't run away.

2. You sell a 30-day call and buy a 90-day call (both $100 strike). When the near month expires, where should the stock be for the biggest gain?

Answer: Around $100.With the stock near the strike, the near month expires worthless while the far month holds the most time value, so the spread is worth the most.

3. You paid $2.74 to open, and the stock soars to $150. By the time the near month expires, roughly what happens?

Answer: You lose close to the $2.74 (the maximum loss).Both calls are deep in the money with little time value, so the spread shrinks toward 0 and the loss approaches the net cost, but no more.

Terms in this lesson

• calendar spread (Calendar Spread): Selling a near-month option and buying a far-month option at the same strike, profiting from the faster decay of the near month; it pays best when the stock sits near the strike.
• implied volatility (IV) (Implied Volatility (IV)): The volatility backed out of an option's market price, reflecting the market's expectation of future swings; the higher the IV, the pricier the option.
• strike price (Strike): The price written into an option contract at which you can buy or sell.
• Theta: How much value an option loses with each passing day; the decay speeds up as expiration nears.
• time value (Time Value): The part of an option's price above its intrinsic value, reflecting the chance it gains value before expiry; it melts away over time.
• Vega: How much an option's price changes for each 1-point rise in implied volatility; longer-dated, at-the-money options have more Vega.