The definition of a calendar spread is buying and selling calls or buying and selling puts at the same strike but different expirations. The strike price that you buy will have more time than the strike price that you sell. The reason for doing a calendar spread is to reduce the cost of the option that you buy. This type of trade takes advantage of time decay. The sold option is going to offset the cost of the option you buy, thus reducing your risk. The net amount of the trade to enter is going to be a cost but you won’t spend as much money. The money spent is the most that you can lose.
Ideally, you want the option that you sold to expire worthless. Ideally, though, the strike price would be close to being in the money. The strategy behind this trade is to have a longer term bias whether bullish or bearish. But short term, you don’t think it will reach your strike price before the shorter expiration.
Let’s give an example. AAPL today closed at $119.94. Based on a triple bottom pattern, you think the stock will reach $125, but don’t expect it to reach it any time within the next few weeks. As of the close tonight, you can buy the April 125 call for $320 and sell the February 125 call for $51 for a net cost of $269 (not including commissions.) In two weeks, we want the stock to be below $125 so that the February option expires worthless. If the stock closes at $124 at February expiration, the April option will be worth about $445 (according to option calculator.) You could close out or hold on longer if you expected more profit. You could even sell another option for March or a weekly option.
If at expiration, the sold option is in the money, you will be called out and lose the net amount spent. So, if you think the sold option is going to be in the money at expiration, you will want to buy it back to avoid the loss and let the long option continue to go in your favor.
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