Calendar Put Spread – A Beginner Neutral Options Trading Strategy

Calendar Put Spread is an options trading strategy used by beginners. This strategy is used majorly in  Neutral Market Conditions.

Know everything about Calendar Put Options Trading Strategy here.

About Calendar Put Spread

The Calendar Spread works more on the future spread strategy which happens to enter both the long term and short term options.

We target the same underlying security and the same strike price. However, the delivery periods for the contracts are different.

We also know it as an inter-delivery spread or intramarket spread. The calendar put spread is a neutral trading strategy majorly focused on earning profits.

It does so by implying the effect of time decay over a fixed security deposit. Also, it could focus on the asset that shows almost no price fluctuation.

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Mode of Transaction for Calendar Put Spread

The calendar put is almost similar to calendar call, the only difference being the mode of transaction. Due to its simplicity, the strategy is suitable for new traders. However, a good knowledge of time decay and profit effect is what a trader needs.

The strategy involves upfront cost as it is a “debit spread “so the maximum loss is the underlying security or the upfront cost. It is a two transaction strategy of trading and requires medium level expertise.

Objective of Calendar Put Spread

The Calendar Put Spread suits well when the underlying asset is least likely to show price variations over a relatively shorter period of time.

This brings to light the neutral outlook of the strategy. Using this strategy, the traders can avoid heavy losses if the price shows an extreme fluctuation in either direction.

The maximum loss the trader has to bear is the underlying asset or the upfront cost used in setting the spread up.

The traders use this strategy efficiently. It helps those who have concerns regarding the failure of the price movement forecast. It helps better, if the prices have a possibility to move significantly.

Setting up Calendar Put Spread

The calendar put spread is a two-step process. The first step involves selling to open order to write the puts on an underlying security shows minimum price fluctuations. The contract must have a short term expiry date.

The second step involves buying an open order to buy the same number of puts on the same security deposit and at the same strike price. However, the expiry date of these bought puts must fall after the expiry date of the written puts.

The trader should do similar buying and selling transactions until the trader can take up the risks of stepping into the legging technique.

The bought puts cost more than the written puts as they have a longer delivery period but, the trader needs to incur an upfront cost for setting up the spread.

Calendar Put aka the Horizontal Spread is the transactions we make at the same strike. Usually, the strikes levels to the underlying asset but to reduce the upfront cost, the trader may quote a lower price.

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Types of the Calendar Puts

The Calendar Put Spread works majorly on the two modes, i.e., Long Put Calendar Spread and Short Put Calendar Spread.

Long Put Calendar Spread

The Long Put Calendar Spread is when the trader sells a short term put option. Also, he might buy another long-term put option. The puts are usually of the same strike however, the trader may consider slightly different strikes.

If the short term put faces a price fluctuation or turns out worthless, the trader is still left with a long term put to continue the trading.

The maximum profit is the strike price less the premiums paid while the maximum possible loss is the net premiums paid.

The trader focuses on selling the short term put at the price of the costlier long term put.

The maximum loss can occur only if both the short and long term contracts turn out to be worthless due to great price fluctuations.

However, the maximum loss is no more than the premiums paid to set up the spread. So the risk of potential loss is highly reduced.

The trader earns a maximum profit if the short term contract sells out at the strike price of the underlying asset. Hence, the amount left after paying the premiums, counts as the profit.

The overall effect of the time decay over the trading is positive. It helps the trader establish a maximum profit gaining strategy.

The volatility of the market does not seem to affect the trade. It is as long as there is no considerable variation in the strike.

Due to the different delivery periods, the breakeven point of the strategy is given by a function. It belongs to the underlying asset, volatility, and time decay rate.

Short Put Calendar Spread

Short Put Calendar Spread is completely opposite to the Long Put Calendar Spread.

It involves buying a put option for a short term and then selling the put at an expiry date that falls after the expiry of the bought put.

Both the to and fro put transactions happen at the same strike price but with different termination period.

The idea mainly is to look for a sharp movement of the asset price in either direction. It happens during the short term contract or a sharp downward movement in the volatility. On a steady stock price, the asset suffers from the time decay.

It is important for the price to move in the short term contract. The maximum profit is the total premium and the net maximum loss is the strike price less the substantial premiums the trader pays. The profit is dependent on the sudden and sharp movement in the underlying stock price.

If the price remains steady, the short term contract turns out worthless. The long-run contract still requires the premiums the trader should pay.

This might incur a potential loss at the trader’s end. However, if the trader decides to take no action over the worthless short term put, it becomes a naked put which ultimately limits the potential losses.

The trader can achieve maximum profit when the prices deviate considerably on either end and the contract reaches the parity.

Either, both the contracts turn worthless, or both get in the intrinsic trades. This gives away a profit of net premiums received by the trader while setting up the spread.

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Profit and Loss Associated with Calendar Put Spread

The Calendar Put Spread calculates the profits and losses based on the rate of the time decay and its effect over the expiration period of the contract.

The trader assumes profits at the idea that the written puts decay faster in value over time than the bought puts.

Since, we assume that the underlying asset shows the minimum movement, there are possibilities that one of the contracts turns worthless.

It might leave over a definite profit according to the mode of spread, either short or long, and leaves behind a profit.

The accurate amount, however, depends upon the factors of time decay and initial investment. The maximum loss in the calendar put strategy is pretty obvious.

If the trader gets out at the end of the contract termination, he will have no liabilities or in hand profit.

The maximum amount he loses is the upfront cost or the underlying security asset. He can pay the bills with the amount and the trader comes out with no net profit or loss and in zero debt state.

Risks Involved with Calendar Put Spread Strategy

The Calendar Put Spread is a splendid strategy for neutral trading as it involves minimal risks of all other strategies.

The traders have more chances to earn than to lose. If the prices move sharply, it can still give away a considerable profit to the trader.

However, in a most unfortunate event, if the trader fails to achieve zero growth, the losses can be limited and there are the least risks of getting indebted.

Hence, no to minimal risk management is what a trader needs in opting for the strategy.

Conclusion of Calendar Put Spread

The Calendar Put Spread is an exceptional idea of trading for beginners or novice traders. It does not involve complex trading strategies.

Good knowledge of time decay comes handy. It can help an investor earn profits without even risking what they have in hand.

The trader can deal with strike variations using any of the two major Calendar Put methods and investors mostly end up gaining good profits.

While the prices are stable, we can use it for earning profits with calculated time decay rates. If the underlying security prices move unexpectedly, the trader is safe from potential losses.

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