The calendar spread is one of the easier to understand and manage option trading strategies. It is also one of the more exciting.

A calendar spread is where you have two options with different expirations but at the same strike. The near month option is sold, while the further out option is bought. The trade makes money if the stock stays within the trade’s breakevens. Thus the spread is done on stocks that will not move much while the trade is on.

Calendar spreads can make money in two different ways. The first is through time decay, also known as theta. As the days go by, a calendar spread will increase in value as the front month option decays. The near month option will decay faster than the farther term option and thus the spread as a whole increases in value.

The second way a calendar spread makes money is through a change in volatility. The volatility of the options impacts how much they are worth. So if the volatility of the front month option falls while the volatility of the back month option does not fall or at least not as much, the trade will make money.

Earnings are a great time to use the calendar option strategy. Going into an earnings announcement, the volatility of the options increases. A common strategy is to sell a calendar into earnings and take it off as soon as the earnings are announced. Normally the volatility of the options falls off a cliff after the announcement.

When trading an earnings calendar spread the sold, near term option should expire after the earnings date, and the long option should be for the next month or further out. That way the volatility drop will cause an enormous loss in premium for the sold option while the long option will retain most of its volatility and option premium.

The risk is if the stock moves too much and breaks outside the breakevens of the trade. At that point a loss can occur no matter how much volatility is lost.

When trading calendar spreads, it is not uncommon to make 20-30% on the trade while being in the trade for 30 days or less. Of course you would need to know how to manage the calendar spread in case it does move outside the breakevens or else you can have a loss. The most you can lose on the calendar option strategy is the amount you paid for the trade. The maximum you can make is close to 100%. But profits that large are rare.

Calendar spreads are an option trading strategy that every option trader should have in their tool belt. It is a great strategy to use when volatility in the market is low and as a play on certain news announcements. But make sure you know how to trade options first.