A calendar spread options strategy can be a great way to profit off a stock with lower volatility but you need to be aware of a few basic rules before throwing your life savings into these strategies. While the calendar spread resembles the iron condor in some ways, there are some key differences:
Calendar spreads are almost always net-debit trades. which means that you will be outlaying cash to initiate the position. Not a big deal as today’s interest rates are extremely low.
Because calendar spreads have less distance between the break-even points, adjustment is an important part of the strategy. In our view, this is a plus, because we can change the profit curve of a position in the middle of a trade, or roll out the short side to get more profit (or give a position thats in the red more time to recover). But the trade-off is that we often pay an extra commission or two, and we need to keep a little extra free cash in our account.
Adjustments often involve moving a portion of our contracts to a different strike price. To keep things simple, you might want to trade in even numbers. We generally like to start with at least 4 contracts (so we can split the position twice, if necessary).
Achieving a situation in which we are long vol puts us in a position to increase profits as the implied volatility increases. However, positive vega can work against us too. Volatility risk can reduce or eliminate the profit potential of certain calendar spreads or, in extreme cases, lock in a loss if implied volatility plummets unexpectedly. We let the trades come to us by only entering a trade that fits our profile; one which enters into a lower volatility trade.
We can only lose what we paid to initiate the options strategy. The key is to keep our losses small by using stop loss rules. We try to keep any one loss small enough that it wont take more than one or two successful trades to make it up but, be prepared for the worst. Never risk more than you can afford to lose and you can usually gauge that by whether or not you can sleep comfortably at night. Paper trade until youre confident that you understand calendar spreads and their adjustments.
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