A Closer Look at Calendar Options Spreads

What you are looking at is a 32-Day-Out Calendar Spread constructed on the RUT.  In  case you didn’t know already, the Calendar options spread is constructed by selling an option and buying an option, but the contract sold has a shorter-term expiration.  The strikes will be the same even though the expiries are not.  Traders tend to do Calendars for positive Theta and positive Vega at the same time.

Calendar Options Spread Insight

Although people tend to think of this as a positive Vega position, it doesn’t always behave as one.  In fact, the Calendar can be used the same way you would imagine a negative Vega trade to be used.  eg.  The Calendar spread can make money when volatility drops, just like an iron condor will do.  This will happen when the front month IV drops faster than the back month, and this happens quite often, especially over earnings.

Positive Vega

That being said, don’t just add Calendars to your portfolio to increase Vega.  It might not work if IV drops faster on the front month.  How do you monitor this?  You’ll need sophisticated software to help you analyze this information, and you’ll need a good education on how volatility changes across the expiration cycles.

Negative Vega

Is the Calendar negative Vega?  Not technically, but as stated, it can make money when IV drops, so it behaves as such in certain situations.  The problem is that you cannot rely on it making money when IV rises or drops unless you really have a deep understanding of volatility; it’s rather unpredictable to most option traders.  You’ll have to do extensive research and practice with your underlying to become familiar with its behavior and its correlations to volatility.

Calendar Options Spread Risk

THESE ARE RISKY TRADES.  They are a gamble, so make sure you know this.  Don’t think they are high probability trades.

The point of the blog image is to illustrate just how risky this type of trade is through the calendar spread risk profile.  Notice if the market moves down 10% quickly, this trade will lose nearly 100%.  Is this the type of trade you should be trading?  Would you feel comfortable with $500,000 into this trade?  If you can’t do it with that, then why do it at all?

Calendar Spreads are not scalable and therefore, they have no future in your portfolio if you plan to grow it over the years.  That’s my humble opinion.