Calendar spread

A calendar spread is an options strategy that involves selling an option that expires sooner and buying an option with the same strike price and the same underlying stock but a later expiration date. Both options are typically the same type, either both calls or both puts, and the strategy is a bet on the passage of time and the relative pace of time decay between the two contracts rather than on a big directional move in the stock.

The option that expires sooner loses value from time decay faster than the one expiring later, since time decay accelerates as an option gets closer to expiration. If the stock sits near the strike price and stays roughly there, the option expiring sooner can expire worthless or be bought back cheaply while the other option retains more of its value, letting the trader profit from that gap. The most a trader can lose is generally limited to the net premium paid to put the position on.

Calendar spreads are typically used when a trader expects a stock to trade sideways for a while but wants to keep exposure to it further out, or wants a cheaper way to express a view that extends well beyond the next few weeks. They can also be used to take advantage of a difference in implied volatility between the two expirations, buying the cheaper of the two options in volatility terms and selling the more expensive one. The strategy performs worst when the stock makes a sharp move away from the strike price soon after the position is opened, since that hurts the value of both legs relative to what the trader hoped for.