A Calendar Spread is an options trading strategy that involves buying and selling options with different expiration dates but the same strike price.
For example, let’s say you want to trade options on Company XYZ, which is currently trading at $50 per share. You can create a Calendar Spread by buying a call option with a strike price of $55 that expires in three months, and simultaneously selling a call option with the same strike price of $55 that expires in one month. This creates a spread where the option with the longer expiration date has a higher premium (price paid for the option) than the option with the shorter expiration date.
The goal of a Calendar Spread is to profit from the time decay (also known as theta decay) of the shorter-term option while holding onto the longer-term option, which has more time value. As the shorter-term option approaches its expiration date, its time value decreases at a faster rate than the longer-term option, resulting in a profit. If the stock price of Company XYZ remains relatively stable during the life of the spread, the spread will be profitable. However, if the stock price of Company XYZ moves significantly in one direction, the Calendar Spread may result in a loss.