Calendar Spread - An Effective Futures Market Trading StyleA Calendar Spread, also known as an Inter-delivery Spread, is the simultaneous purchase of one delivery month of a given futures contract and the sale of another delivery month of the same commodity on the same exchange. This type of spread is called a "calendar spread" because it is based on different calendar months. For instance, buying a June electricity contract and simultaneously selling a September electricity contract. A market participant can profit (or lose out) as the price difference between the two contracts widens or narrows.Why Trade In a Calendar Spread?The primary reason for trading in a Calendar Spread is to take advantage of disparities in volatility between near-term options and options of a deferred month. By selling a short-term option with a sharply higher volatility than a longer-term option of the same strike price, a trader can establish a position that can be profitable over a wide range of underlying prices.
Calendar spread should be traded when the trader feel confident that a stock or futures market will remain in the profitable range. For example, say XYZ stock is trading at 65 in March. The May 65 strike put option is trading at 14.50 with an implied volatility of 24. At the same time the August 65 strike put option is trading at 18.75 with an implied volatility of 20. The near-term option (May) is trading at a volatility that is 20% more than the longer-term (August) option. The price of the May option in this example is comprised solely of time premium. As expiration nears, this time value will decay to zero. While the August option will also lose some time premium, it will not lose nearly as much as the near-term May option. This trade will show a profit at expiration if the price of XYZ stock is between approximately 40 and 109. Outside of this range, losses will occur. The profit/loss graph of a call calendar spread has the same general characteristics and shape as the put calendar spread. Inter-delivery spreads are categorized into two: * Bull spread * Bear spread Day-Trading-Strategy .com, P.O. Box 89029, Houston Texas, 77289 info@Day-Trading-Strategy.com |