Option Trading Calendar Spreads Time Decay

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Option Trading: Calendar Spreads & Time Decay


Overview


When discussing calendar spreads in option trading, traders typically refer to buying options for a farther month and selling those for a nearer month. While this strategy works in many cases, it's not universally applicable to all options.

General Insights


Prices fluctuate, so I'll keep this discussion broad to avoid confusion.

Out-of-the-Money Options


For out-of-the-money options, consider the reverse strategy: buy the nearer month and sell the farther month. This approach takes advantage of theta, which is beneficial when purchasing the front month. The greater the distance between the months, the more advantageous it can be. Additionally, analyze the cost per day of each option. Sometimes, options equidistant from the futures can differ drastically in daily cost, with one being significantly cheaper.

At-the-Money Options


For at-the-money options, traditional calendar spreads?"buying the farther month and selling the nearer month?"remain advisable.

For options with strike prices far out of the money, the reverse calendar spread might be more effective. This is due to the favorable theta and daily pricing.

Practical Tips


- Monitor out-of-the-money options, evaluating their daily costs and theta, and compare across different months.
- Ensure the option you plan to buy is as far or farther away in strike prices from the underlying as the one you intend to sell. For example, if you purchase an option that’s five strikes away, the one you sell should be at least five strikes away too. This ensures that in case of a significant market move, both options become in-the-money at about the same time.

By considering these strategies and market dynamics, you can make more informed decisions in option trading.

You can find the original non-AI version of this article here: Option Trading Calendar Spreads Time Decay.

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