Calendar Spread – My Beloved Monthly ATM Machine
For a Spread Trading Example let's look at the Calendar Spread Option Strategy as an income generating trading technique that is viewed favorably by both professional option traders as well as the members of the retail trading crowd.
The calendar spread is usually considered a neutral trade – a position that performs its best when the underlying being used remains trading in a range. It creates a profit from the fact that options are a decaying asset – and the options that were sold in the position lose value over time at a much faster rate than the option that were bought. When the trade is taken off, this difference is what leaves the trader with a profit.
Calendars can be constructed from either all call options or all put options. To build a calendar spread, one would sell a near month option on their chosen stock or index – and then buy a later month option at the exact same strike. Once again, because options lose their value at a much faster rate the closer they get to expiration, the closer month which was sold will shed it's value much faster than the option that was purchased in the later month – creating a difference in values that if managed and traded correctly can produce a very nice payoff to the trader.
Following is a hypothetical example of a calendar spread on the DIA: Sell 5 Nov 101 call. Buy 5 Dec 101 call.
In the example shown above, this calendar was constructed with options trading in back to back months (the sold November option and the purchased December option). Keep in mind however, that it isn't necessary to always construct calendar trades in this way – for example, one could create a calendar where the sold option was a near month – and the purchased option is several months away (instead of being the next following month). In other words, calendar spreads can be built using a variety of different month options with varying lengths in between.
For example, instead of using a December option as the purchased option in the sample above, one could instead purchase a January option, or a February option, or even a March.
The the most part, the calendar spread strategy is put on when the one trading it has a neutral outlook on the the stock or index being traded. However they can also be used as a speculative trade if one were to believe that the underlying vehicle being traded was going to be making a move to a particular area on the price chart within a certain period of time. To do so, the trader would simply place a calendar spread at the strike price where they believed the stock / index was would be trading at expiration day.
Article Source: Http://EzineArticles.com/?expert=Ted_Nin…