Bullish Calendar Spread

Low-Cost, Low-Risk, Directional Play.

Bull and Bear
Bullish? Bearish?. Google Images

Most traders enter the market with a directional bias (bearish or bullish). A minority prefer to trade with a market-neutral bias and choose strategies that earn money when the stock market trades within a narrow range.

Options are very versatile investment tools, allowing traders to choose from among a variety of strategies. The following discussion is about one of the lesser-know ways to express a directional bias.

When the trader successfully predicts direction, this strategy offers the possibility of earning an outstanding return.

Using a previous scenario:


  • You are interested in taking a position in XYZ.
  • Current stock price: $62 per share.
  • Current implied volatility (IV) is 40, near its historical average.
  • Date: August expiration arrives in 25 days; September expiration in 53 days.

Using a calculator from the CBOE, the following values were determined:

XYZ Aug 70 call: $0.42
XYZ Sep 70 call: $1.22
XYZ Sep/Aug 70 calendar spread: $0.80

One reason why this spread is attractive is that the initial cost is not too high ($80 per spread - especially when compared with the possible gain.

Scenario 1. 25 days later, it is 3:55 pm ET on expiration day. XYZ is $69.95

This is an outstanding situation. You can sell the spread (pay $0.05; sell at $3.05). Profit is $2.20 per spread or 275% ROI.

Important NOTE: It is not wise to expect to own the calendar spread this near to expiration (just 5 minutes from the present time; see risk discussion below), but it is a possible result and is worth mentioning.

Scenario 2. 14 days into the trade; XYZ is $65

The calendar spread is worth $1.23 (Aug call is worth $0.34 and the Sep call is worth $1.57)

Notice that the stock is rising, per your expectation and you can lock in a profit near $0.43. (NOTE: DO not expect to be able to close the position at its theoretical value.

The current market value of the options will illustrate just how much you can get when selling the spread. However, knowing the fair value of the position gives you a good idea of just how much to ask. You do that by entering a limit order to sell the calendar spread at whatever price you are willing to accept.

If you earn that $0.43 profit,the return on your investment would be greater than 50%. Depending on your current outlook for the stock price, this could be a great time to take your money to the bank. Obviously, you can hold longer when you want strongly believe that the stock will continue to rally as time passes. But don't be too greedy. It is a good idea to write a trade plan when initiating the trade -- and that plan would include a profit target.

Scenario 3. 21 days into the trade. XYZ is $66.

The calendar spread is worth $1.50 (Aug call is worth $0.10 and the Sep call is worth $1.60)

Another fine profit-taking opportunity. Why? Because the markets do not always go your way and holding onto this position involves risk. So far all has worked according to plan and the profit is excellent (did you achieve the profit target stated in the trade plan? If yes, this is not the time to become greedy).

Scenario 4a. 24 days into the trade. XYZ is $64. Implied volatility (IV) holds at 40.

Spread value: $0.92 ($0.00 and $0.92)

Scenario 4b. 24 days into the trade. XYZ is $64. IV declines to 36.

Spread value: $0.70 ($0.00 and $0.70). Notice that the previous gains have been lost and the position is underwater (losing money).

There are two important takeaways:

  • Most of the time, the spread will continue to earn money as the stock continues to rise. However, as expiration gets nearer and If the rally stalls, each passing day can hurt the value of the spread.
    NOTE: At first, the spread increases in value as time passes -- until the first-to-expire option has lost so much of its value that the passage of another day means little. After that point, the longer-term option has a greater Theta and loses value more quickly than the nearer-term option.
  • Implied volatility tends to decline during market rallies (this is not always true, but it is a reasonable expectation) and the spread's value is very subject to that implied volatility. See the second Table in the first post on calendar spreads for an example of how the value of an ATM IBM spread is very dependent on IV.

Skilled risk management involves taking a close look at the current value of every position that you hold -- and understanding the risk and reward going forward. Money earned yesterday or last week is not relevant because you manage risk by evaluating the risk of holding the position from now into the future. 

TENET: You must want to own any position at the current price. If either of the following is true, then consider getting out of the trade.

  • The money at risk is too great, compared with the possible gain.
  • The probability of earning money -- starting today -- is not high enough for the risk involved.