I have created a short video which explains why I like calendar spreads. It also shows the exact positions we hold in 3 Terry’s Tips actual portfolios so you can get a better idea of how we use calendar spreads.
I hope you will enjoy the video, and I welcome your comments.
The basic reason I like calendar spreads (aka time spreads) is that they allow you to make extraordinary gains compared to owning the stock if you are lucky enough to trade in a stock that stays flat or moves moderately higher.
I get a real kick out of making serious gains when the stock just sits there and doesn’t do anything. Calendar spreads almost always do extremely well when nothing much happens in the market.
While I call them calendar spreads, if you look at the actual positions that we hold in our portfolios, you will see that the long calls we own are not always at the same strike prices as the short calls we have sold to someone else. That makes them diagonal spreads rather than calendar spreads, but they operate exactly the same as calendar spreads.
With both calendar and diagonal spreads, the long calls you own decay at a slower rate than the short calls that you have sold to someone else, and you benefit from the differences in decay rates. Both spreads do best when the stock ends up precisely at the strike price of an expiring option. At that point, the short options expire worthless and new options can be sold at a further-out time series at the maximum time premium of any option in that series.
If you have sold short options at a variety of strike prices you can make gains over a wider range of possible stock prices. We use the analyze tab on the free thinkorswim software to select calendar and diagonal spreads which create a risk profile graph which provides a break-even range that lets us sleep at night and will yield a profit if the stock ends up within that range. I encourage you to try that software and create your own risk profile for your favorite stock, and create a break-even range which you are comfortable with.