These notes are taken from the Raleigh “Durham Group Meeting Mark Mosley Calendar Spreads” found on youtube.

Here is an updated presentation to the original.

Tax Considerations

  • IRS section 1256 trades are taxed at a rate of 40% short term Capital Gains (like your paycheck) and 60% long term Capital Gains (about half the rate of your paycheck)
  • Qualifying Instruments SPX, RUT, NDX.

What is a Calendar Spread ?

  • A bullish position- Sell a put (short dated) combined with…
  • A bearish position- Buy a put ( long dated)
  • Long and short legs are at same strike price.
  • We would like the option we sold to decay in value, while…
  • We would like the option we bought to retain as much value as possible.

Entry Rules for calendar spreads

  • Enter any time, except do not enter during a volatility spike.
  • Sell a At-The-Money Put or Call 60 to 80 DTE (Days to Expiration)
  • Buy a long option the same strike 30 days beyond your short strike

Why not a shorter term?

  • terrible Risk/Reward ratio 
  • Narrow Range of safety

Pros of Longer-term

  • Wide Range of safety
  • If market crashes slower loss over time and time to adjust

What about the Greeks? 

Options Price = Delta + Theta + Vega 

  • Delta = measurement of your directional risk
  • Theta = Positive money flow
  • Vega = Sensitivity to changing Volatility

In Think or Swim, you can find this on the analyze tab.

Management Rules

  • Aim to keep delta under 30 percent of theta +/-
  • If trade is threatened either top or bottom we add a 2nd calendar ATM and manage the 2 as a pair, keeping Delta/Theta ratio under 30 %
  • Manage according to Delta/Theta ratio and position under profit tent
  • Try to ignore managing according to Profit/Loss dollar amount since it is normal to see wild swings in your daily P/L, due to constantly changing volatility levels.

But how are Calendar spreads affected by volatility? 

  • Remember we want the leg we sold to decrease in value, and we want the long leg to retain value or increase.
  • Volatility across time vs. volatility across strike price in the same expiration.

Term structure of Volatility

  • In Options trading, Implied Volatility is how the market is pricing risk
  • Normally short term contracts have a lower IV compared with longer term
  • In a calendar spread, short and long leg IV can move independently of each other. This dynamic can give Calendar Spreads both positive and negative vega attributes.
  • In practice, this is normally not a problem since IV is mean reverting.

So, How does volatility affect Calendars? 

  • They can be both positive and negative vega, depending on how volatility is converging or diverging.
  • Traditionaly considered Positive vega, meaning benefit from increasing volatility
  • But can be Negative Vega, meaning benefit from falling volatility

Implied Volatility continued… 

  • Remember, we sold a short dated leg…..if its volatility goes up, our position is hurt, if its volatility goes down we benefit.
  • We bought a long dated option, if its IV goes up, we benefit, if its IV goes down, we are hurt.

How to handle changing volatility? 

  • Manage according to Delta/ Theta ratio, your Profit/Loss figure can swing wildly and your trade still be OK.
  • Because Volatility is mean reverting, giving your trade time will usually repair any adverse moves in your Profit/Loss. 
  • Because we are Theta Positive, time heals all wounds.  (usually) 
  • Most of all, don’t Worry! 

Most aggressive management rules

  • Monitor delta/theta relationship keeping it under 20%
  • Closing the trade is a day to day decision making process, weighing Delta/ Theta, considering position under the profit tent, and technical analysis forecasting market direction.
  • Consider taking profits at 15%, for aggressive traders, let run to 30 %.
  • Time- close by 30 DTE, or aggressive traders, no later than 21 DTE.

Exit rules 

  • A conservative strategy would be to take profits at 10% of invested capital and close the trade, rolling out in time to the next expiration closest to 60/90 DTE
  • A more aggressive strategy would be to hold closer to expiration and take profits at 20 to 30% of invested capital.
  • Exit if time to expiration on short dated leg falls below 30 days.

Management tip

  • If you ever unsure of the market, or the stability of a trade, you can always close the trade and roll out in time, aiming for at least 60/90 DTE entry.
  • You can always cash out if worried about bad news.
  • Keep profit tent over the ATM line on your graph, regardless of the greeks.
  • You can always layer a second or third trade