Horizontal Spread

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Horizontal Spread (Calendar Spread): What It Is and How It Works

Key takeaways

  • A horizontal (calendar) spread uses long and short option or futures positions on the same underlying and strike price but different expiration dates.
  • It is typically constructed to reduce the impact of time decay and to trade expectations about near-term volatility.
  • Long calendar spreads benefit from rising implied volatility and limited upfront risk (debit equals maximum loss).
  • Reversing the structure (short calendar) aims to profit from falling volatility and has different risk characteristics.

What a horizontal (calendar) spread is

A horizontal or calendar spread pairs two otherwise identical derivative contracts that differ only in expiration month. One contract is bought and the other sold simultaneously at the same strike. The price difference between the near- and far-dated contracts reflects the market’s expectation of change between those dates (time value in options, expected price change in futures).

How it works (mechanics and intent)

  • Constructed by buying a longer-dated contract and selling a nearer-dated contract at the same strike (common long calendar).
  • The strategy reduces the net effect of time decay because the short, near-term option loses value faster than the long option.
  • Profit typically comes from favorable moves in implied volatility or from price behavior between the two expirations (for options, increased volatility benefits a long calendar because longer-dated options have higher vega).
  • A short calendar (buy near, sell far) reverses the trade and generally seeks to profit from falling volatility.

Options vs futures

  • Options: Time value and implied volatility are central. A calendar spread neutralizes some time decay and is used to express views on volatility changes between expirations. Longer-dated options are more sensitive to volatility (higher vega), so rising implied volatility tends to help a long calendar.
  • Futures: There is no explicit “time value” like in options; price differences reflect market expectations for the underlying at different delivery months. Futures calendars are often used to trade short-term price expectations or seasonality.

Example (simplified)

Assume a stock trades near $89 and you use 95-strike calls:
* Sell Feb 95 call for $0.97 (receive $97).
* Buy Mar 95 call for $2.22 (pay $222).
* Net debit = $2.22 − $0.97 = $1.25 ($125 per contract) — this is the maximum loss.

Typical profitable outcome for a long calendar:
* Near-term volatility rises and the underlying moves so that the near-term option expires worthless (or close to it) while the longer-dated option retains value.
* Example objective: price rises but stays at or just below the strike by the near expiration, letting the short option expire worthless while the long option still benefits from remaining time value and higher implied volatility.

Uses and strategy variations

  • Income/low-cost exposure: Buying the long-dated contract while selling nearer-dated options reduces the initial cost versus buying the long option outright.
  • Volatility play: Long calendars express a bullish view on near- to mid-term volatility; short calendars express a bearish view on volatility.
  • Market bias: Depending on strike selection, calendars can be structured for neutral, mildly bullish, or mildly bearish expectations.

Risks and considerations

  • Maximum loss for a net-debit calendar equals the premium paid.
  • Profit is not unlimited; outcomes depend on time decay, volatility moves, and price action relative to the strike at the nearer expiration.
  • Implied volatility levels can differ across expirations and change unevenly; that can alter expected payoff.
  • Short calendars (selling the long-dated and buying the near-dated) often carry greater risk if volatility rises unexpectedly.

Conclusion

A horizontal/calendar spread is a flexible derivative strategy to trade differences in time and volatility between two expirations while limiting upfront cost. It’s commonly used by traders who want to capitalize on expected volatility changes or to reduce the premium required to hold a longer-dated position. As with any options/futures strategy, understand the effects of time decay, implied volatility (vega), and strike choice before implementing.