Options trading offers a range of strategies, each suited to different market conditions and objectives. One such strategy, the calendar spread, stands out for its potential to leverage time decay and implied volatility differences.
In this article, we’ll explore the mechanics of a calendar spread, when to use it, and walk through a real-life example of a trade on Goldman Sachs (GS). At the end, you’ll find a video breaking down this trade in detail—a perfect opportunity to enhance your learning.
What Is a Calendar Spread?
A calendar spread, also known as a time spread, involves selling a short-term option and buying a longer-term option with the same strike price. This strategy is designed to capitalize on the differences in time decay (theta) and implied volatility (IV) between the two options.
Here’s how it works:
- Sell a near-term option: This generates income and takes advantage of faster time decay in the shorter expiration period.
- Buy a longer-term option: This provides protection and allows for potential gains if the underlying asset’s price moves favorably.
- Both options share the same strike price and are on the same underlying asset, but they differ in expiration dates.
The result is a position that thrives when the price of the underlying asset moves toward the strike price near the shorter option’s expiration date.
Example: Calendar Spread on Goldman Sachs (GS)
Let’s dive into a real-world example of a calendar spread trade I executed on Goldman Sachs (GS), targeting a price of $220.
Trade Setup
- Underlying Asset: Goldman Sachs (GS)
- Strike Price: $220
- Expiration Dates:
- Short leg: 18 days to expiration
- Long leg: 25 days to expiration
- Implied Volatility: Short leg IV = 40%, Long leg IV = 37%
- Quantity: 4 contracts
- Entry Price: $0.56 debit per spread
Why This Setup?
- Target Price: I anticipated GS to hover around $220 within the 18-day timeframe.
- Implied Volatility Backwardation: The higher IV on the short-term option provided a premium advantage, while the lower IV on the longer-term option reduced costs.
- Time Decay: The position benefited from the rapid time decay of the short-term option.
Managing the Trade
Managing a calendar spread involves scaling out positions and monitoring key factors like earnings reports and market fluctuations. Here’s how I managed this trade:
- Pre-Earnings Adjustment:
- With GS’s earnings report approaching, I closed one-fourth of the position at $1.23, locking in profits and reducing risk.
- Scaling Out Further:
- Over the next few days, I closed additional portions at $1.33 and $1.40 as the market moved favorably.
- Final Exit:
- Two days before expiration, market conditions shifted, and I closed the final quarter at $0.95, concluding the trade with a $267 profit (over 100% return).
Watch the Full Breakdown
Want to see this trade in action? In the video below, I walk through the setup, adjustments, and final results of the Goldman Sachs calendar spread trade. By watching, you’ll gain deeper insights into the thought process and execution of a successful options strategy.
