Long Call Calendar:

•  Long 1 call.
• Short 1 call at a shorter duration and the same strike.

Long Put Calendar:

•  Long 1 put.
• Short 1 put at a shorter duration and the same strike.

<Calendar spread risk graph retrieved from IB’s Trader Workstation>

A calendar spread is a time spread. A long calendar spread is a long option and a short option of the same type and strike but with less DTE (days to expiration). For example, a long put calendar spread in April would be long a put (ex. For June) and then short a put on the same strike but with less DTE (for May). Likewise, a long call calendar spread would be long a call and then short a call at the same strike but with less DTE.

Intermediate: Practical Application

Opening a long calendar spread can be an effective way to make a trade based on an expectation that the underlying price will remain within a contained range in the near term. These types of assumptions are relatively safer when we model the market to have positive gamma. Specifically, if the market appears to be drawn into the Absolute Gamma strike, then setting up a long calendar on that strike might be a reasonable way to play that out. While these horizontal [calendar] trades have defined risk, they are more difficult to manage than vertical spreads. 

Advanced: Term Structure Edge and Tactics

Determining edge with these trades is more difficult than with a simple [vertical] skew calculation which can subtract the difference of IV% (implied volatility) between different strikes on the same date. 

The general idea of a calendar spread is to seek term structure edge, which would mean that the front month has higher (or at least relatively elevated) IV% as compared to the back month after forward implied volatility is calculated. 

If there is heavy event vol on a front month, such as from upcoming earnings or a major economic event like CPI, then there can be term structure edge in writing on that front month and forming a calendar spread. However, if realized volatility spikes on the front month, then it can quickly approach a status near max loss. With long calendars it is typical for max loss to be greater than max profit. 

If legging out (closing part of a spread), always remember that it is safer to leg out of a short option than a long option. For example, the front month might have IV crush and little movement in the underlying security. This would be an ideal situation since that front leg would be near max profit. And then the long contract on the back month could continue, but now with uncapped opportunity (as a single-leg long option).

Long calendars can also be used to lean bullish or learn bearish. Rather than diagonalize the strike (make the front month further OTM), simply making both puts OTM can make a calendar lean bearish and making both calls OTM can make a calendar lean bullish.

Expert: Synthetics

One uniquely identifying characteristic of calendar spreads is that intrinsic value is curved. This is also the case with diagonals (a combination of a vertical and a calendar) and has to do with competing dynamics between the back and front month contract, specifically how the time decay on the front month accelerates much more than it does on the front month, especially if there is little or no movement in the underlying from the pinned strike. 

The synthetics of calendars are straightforward in that swapping the calls out for puts (long for long and short for short) have nearly identical Greek and profit dynamics. However, they might be different enough (between put and call calendars) that it is worth a look to see if one has a better reward/risk/chance dynamic or a tighter bid/ask spread. 

Also, long calendars have nearly equivalent profit/loss dynamics and the same risk graphs as short butterflies, which set up a trade to bet on the price ending up in a specific and tight range. The strike selection of a calendar determines the location of that pin. This means that if you expect the price to end up right where it is [presently] that you would set up a long calendar at the money. 

However, if you expect the price to drift down, then you could select a long put calendar that uses OTM puts (at a lower strike). And if you expect the price to drift up, then you can select a long call calendar that uses OTM calls (at a higher strike). Via put-call parity, you could use a put or a call calendar in either situation, but OTM strikes are generally more liquid than ITM strikes and they have tighter bid/ask spreads.

Absolute Gamma: Absolute Gamma is the strike with the largest total gamma. It can be treated as a strong support/resistance level and a magnet. It is also normal for this level to be near an inflection point like Zero Gamma rather than near the far edges of the trading range. 

back month: A back month in an option strategy is the one with higher amounts of days remaining to expiration. Without context, usually the front month means the immediate month (30 days to expiration) and the back month means the one behind it (31-60 days to expiration).

front month: When comparing option contracts that expire in different months, the front month has the shorter DTE (days to expiration).  

bid/ask spread: The bid is the highest price buyers are willing to pay for a security, and the ask is the lowest price that sellers are willing to sell a security. The difference between these prices is the bid/ask spread. Highly liquid securities (having many active buyers and sellers) such as SPY usually have a bid/ask spread of only one cent, even in the premarket and postmarket. Examining the width of the bid/ask spread can be a more reliable way to gauge option liquidity than volume or OI.

calendar spread: A calendar spread is a horizontal option strategy which means that it is buying and selling option contracts that are on the same strike but different dates.

debit: In an option strategy, there is a debit paid from long options or debit spreads. This is the premium paid for the opportunity to hold the position. The debit also functions as the max loss of a long option position. The counterparty receives a credit as time decay income (theta) until the option expires but takes on risks which can lead to losses and be significant if from an open-ended position. 

debit spread: In an option strategy, a debit spread is one that has a net debit (upfront cost) paid for long options. This means that there is an upfront cost which must be outperformed by expiration, however there are rights instead of obligations (which keeps the option holder in control). Unless a debit spread is deep in-the-money, it would be very unlikely for the short leg to be assigned. But if it was, then that assignment would be strongly offset by the long option leg. For out-of-the-money debit spreads, they are long gamma (accelerating directional exposure), long vega (sensitivity to implied volatility), and short theta (which means the premium gradually decays the value of the option over time). This time decay is measured by a first-order Greek known as theta.

defined risk: In an option strategy, if risk is defined then it is structured so that it has a max loss (capped total loss on a trade) rather than potentially unlimited loss.

diagonal spread: A spread that has both a horizontal (time) and vertical (price) difference between strikes. The horizontal aspect allows volatility to be traded from one month to another. And the vertical aspect allows a directional thesis to be combined with the strategy. As an example of a long put diagonal, a put could be bought 60 days out and then a different put sold 30 days out (horizontal) at a lower strike price (vertical)

DTE (days to expiration): Every option has a DTE figure which counts down how many days are remaining in the contract. It depends on the broker, but this is generally posted right at the top of each option chain. The DTE of an option is always one of the most important components of setting up an option strategy.

edge: An edge in trading is a competitive advantage but not one that guarantees a profit. It can be any method, idea, or tool which helps to outperform randomness. One way to interpret an edge is that it has a positive expectancy, which means that it would prevail as net profitable after many (ideally hundreds or more) occurrences. A single losing trade can be a good trade the majority of the time and a single winning trade can be just lucky without an edge.  The bottom line is that if you have edge in your trading then you have a positive expected value, where you should come out on top if your trading size is managed well enough that no single trade causes too much loss and allows for many attempts.

event vol: The extra amount of implied volatility that builds up on an option contract and inflates its price at major economic events such as earnings announcements. It is normal for this implied volatility (and the price boost which comes with it) to deflate after events. This is an extra steep premium which gets placed on options when there is the most specific demand for them, as these events can often lead to very severe moves. Event vol can be played on both sides: Either a trader goes long and considers the event vol to be at an acceptable premium—or short options are set up to harvest that extra premium as it deflates. However, without credit spreads (which limit the risk), those short options can take on extreme tail risk, undoing a year or more of small gains from these types of setups.

forward IV: Forward IV is the difference in IV that can be derived from two points on the term structure. It tells us how much IV needs to change from one date to the next after being adjusted for DTE (days to expiration). Forward IV is calculated as the square root of the difference in variance divided by the difference in time, with time (T) being the DTE. This can be expressed as: (T₂*σ²  - T₁*σ²)  /  ( T₂ - T₁). The DTE is multiplied against the IV% to weight it.

front month: When comparing option contracts that expire in different months, the front month has the shorter DTE (days to expiration).  

gamma: A second-order Greek which compares changes in delta (directional exposure) to changes in the underlying. In general, gamma means the acceleration of directional exposure. Gamma is also one of the main properties of an option: All long options are long gamma. In a way, gamma is thought of as the magic of options because the size of directional exposure (delta) increases as it is right about direction (therefore increasing profits), and it decreases when it is wrong about direction (therefore decreasing losses). But the cost for this magic is time decay. The connection to market makers is that when they are long gamma (market gamma is positive) then they trade against the direction of the trend to lock in profits after they have favorable moves with increased size thanks to gamma. This is why positive market gamma tends to create an environment of reduced or reducing realized volatility (smaller overall price moves).

Greeks: An option Greek is a type of risk metric that compares the change in one thing to a change in the other. A first-order Greek is the change in one thing compared to a change in the price of an option. The major first-order Greeks are delta (sensitivity to direction), vega (sensitivity to implied volatility), and theta (sensitivity to time decay). 

ITM (in the money): An option is in-the-money if it would still have some [intrinsic] value if the option expired with the underlying price where it currently is. Being in the money is entirely about the strike price beating the underlying price. ITM options cost more than options at or out of the money; they also have less extrinsic value. Additionally, ITM options have more deltas (immediate directional risk).

IV (implied volatility): The expected percentage range over a year with 68.3% confidence. This is based on options pricing at one standard deviation. Long options benefit from increases in implied volatility and short options benefit from decreases in implied volatility. In general, when implied volatility increases it means that the expected percentage range is getting larger. When implied volatility is applied to lengths of time other than one year, then this is called the expected move.

IV crush: A sharp drop in implied volatility which causes the price of an option to deflate. Short options benefit from IV crush and long options lose value from IV crush.

leg out: Legging out of a strategy is when one part of an options spread is closed before the other part(s).  For example, if one has a debit put vertical (long put and a short put at a lower strike) which loses money on a large move up in the market, then the short put can be closed for a profit. This would partially subsidize the long put and give it a chance to run without a spread if the market crashes back down. As an important point on risk management, it is always safer to leg out by closing a short option—rather than a long option—because this way the risk still remains defined (limited).

long call: To be long (buy and hold) an option contract which has limited risk and unlimited potential gains from moves up in the underlying price. The max loss is the cost of the call. Going long on a call is a simple way to gain upside exposure to movement in an underlying security, however the underlying security (such as a stock) must outperform the premium placed on that call by the options market. In other words, a long call must beat the options market in order to profit. If closed early (well before expiration) then a long call must outpace the expected move (priced in by the options market) for a specific period of time. All long calls have long gamma and long vega but short theta. It is uncommon to exercise calls rather than simply close them for a profit, however a long call is frequently understood as a right to exercise (trade in the long call to be long 100 shares) if above the specified strike price. Synthetically, a long call becomes logically equivalent to a long put if also short 100 shares.

long put: To be long (buy and hold) an option contract which has limited risk and amplified potential gains from moves down in the underlying price. The max loss is the cost of the put. Going long on a put is a simple way to profit from  downside exposure to movement in an underlying security, however the underlying security (such as a stock) must outperform the premium placed on that put by the options market. In other words, a long put must beat the options market in order to profit. If closed early (well before expiration) then a long put must outpace the expected move (priced in by the options market) for a specific period of time. All long puts have long gamma and long vega but short theta. It is uncommon to exercise puts rather than simply close them for a profit, however a long put is frequently understood as a right to exercise (trade in the long put to become short 100 shares) if below the specified strike price. Synthetically, a long put becomes logically equivalent to a long call if also long 100 shares.

OTM: An option is out-of-the-money if it would have zero value expiring with the underlying at its current price. When an option is out-of-the-money, its entire price is made of extrinsic value, which is a premium that option buyers are willing to pay for an opportunity to make a profit.

put-call parity: In options, put-call parity is a property of theoretical options pricing models which establishes how calls can have equivalent profit and loss dynamics to puts (as well as Greek dynamics). The logical equivalence of different option structures via put-call parity is known as synthetics. For a long call to be a synthetic match, having a similar or identical payoff profile, a trader can buy 100 shares of stock and buy a put at the same strike and time expiry. For a long put to be a synthetic match, a trader could short 100 shares of stock and buy a call option at the same strike and time expiry. 

RV (realized volatility): Shows the actual trading range of how much a stock is moving over a specific period. It is calculated based on historical movements, and measures the standard deviation, which means about how far it can be expected to move with a 68.3% chance. Another way to look at it is that 68.3% of historical moves would have fallen under what is measured as a standard deviation. Realized volatility can be applied to any length of time. It can also be used as a forecast of future [realized] volatility.

straddle: A vertical option strategy which is long a call and long a put at the same strike (long straddle) or that is short a put and short a call at the same strike (short straddle). For retail traders, this is arguably the cleanest way to trade volatility (changes in the percentage range of a security) directly.

strangle: A vertical option strategy which is long an OTM (out of the money) put and long an OTM call at different strikes (long strangle) or that is short an OTM call and short an OTM put at different strikes. Like a straddle, a strangle is a way to trade volatility. Long strangles have less accuracy and less cost than long straddles; short strangles have more accuracy and more risk than short straddles.

strike: The price that an option is based on. A long call will expire worthless if the price of the underlying security finishes underneath the strike price, and a long put will expire worthless if the underlying finishes above the strike price.

synthetics: In options, synthetics are different structures that have the same logical dynamics, including the same max loss, max profit, chance of winning, and option Greeks. Synthetics are possible because options have the property of put-call parity. For spreads, long puts can be swapped for long calls and short puts can be swapped for short calls (and vice versa) in a way that creates synthetic matches without the need of adjusting deltas with shares. On single-leg options, however, puts and calls can be swapped in the same way, but require directionally-offsetting positions in the underlying security (such as a certain amount of shares).

term structure: A two dimensional graph of implied volatility (y-axis) compared to time (x-axis). IV (Implied volatility) is the expected percentage range over the next year—based on option prices—with 68.3% confidence. One important dynamic of term structure is that it is not simply enough to compare different IV% amounts side by side for term structure edge. Rather, different IV% amounts must first undergo a calculation for forward IV. After this calculation, if one IV% is higher than the other, then there can be a term structure edge in buying the lower IV% and selling the higher IV%.

underlying price: A reference to the immediate price of the underlying security. This is also sometimes called spot (the spot price of the underlying). The spot price is in contrast to derivatives which have option prices or [forward] futures prices.

vertical spread: Any option strategy which has all contracts expiring on the same date. In contrast to a horizontal spread (calendar) or diagonal spread (combination of vertical and horizontal strikes), vertical spreads are usually the most directional and also the easiest to manage. With vertical strategies, the main edge at play is usually skew (differences in implied volatility for different strikes on the same date). Implied volatility is the expected percentage range over the next year—based on option prices—with 68.3% confidence.