Think implied volatility is likely to rise? Want to put on a position that can potentially profit from an increase in IV?
Then a long options calendar spread might make sense.
A long options calendar spread is comprised of long calls or puts and short calls or puts. These calls or puts, however, have different expiration dates.
If you expect a move lower and a corresponding increase in implied volatility, you might consider a long put calendar spread.
Here’s how to do it:
- Choose a strike price for the puts
- Sell the front month put
- Buy the deferred month put
- Manage the position
When choosing a strike price for the puts, you ideally want to choose a strike that may be reached, but not before the front month short puts expire.
The horizontal type of put spread uses puts of the same strike price; however, a vertical strategy may also be used with different strike prices.
A long horizontal put calendar spread is limited in risk to the debit paid but may have unlimited profit potential.
Trader Joe believes that stock ABC will decline in the coming weeks and see a significant increase in implied volatility.
ABC is currently trading at $40 per share.
Joe initiates a long put calendar by selling the front month $35 puts and purchasing the deferred month $35 puts. Joe collects a premium of $.50 for the sale of the front month puts and pays a debit of $1.50 for the deferred month puts for a net debit of $1.00 per spread.
Because options with more time are more sensitive to changes in IV, a sharp increase in implied volatility may pump up values in the long puts at a faster rate than the short puts and can potentially produce a profit.
If the short front month puts expire worthless, and the stock begins a rapid decline, the long $35 puts can potentially profit all the way down to zero.
If the stock falls faster than expected and drops below the $35 strike price before the front month puts expire, a trader may realize the maximum loss potential of the debit paid.
The long put calendar spread is just one method for playing a potential increase in implied volatility. These spreads are simple to initiate, have defined risk and potentially unlimited profit potential. This type of options strategy has a place within the trading arsenal of both experienced and novice traders.