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Stocks & Commodities V. 28:7 (50-55): The Double Calendar Spread by Jay Kaeppel
OPTIONS

ties see their prospects reduced to a

simple formula. If you buy a given
stock or futures contract, that stock or
commodity must see its price increase
in order for you to make money.
Conversely, if you sell short a given
stock or a futures contract, that stock
or commoditys price must decline in
order for you to profit. There are no
other possibilities.
This is not the case when trading
options.
Over the years, traders have devel-
oped and refined a number of strate-
gies designed to help them make
money when a given security is going
nowhere. One such strategy is known
as the calendar spread. Traders have
long used calendar spreads as a neu-
tral play on numerous stocks, indexes,
and futures contracts. But intrepid
traders also never stop looking for
ways to improve their odds of success
and put their probabilities as far in
their favor as possible.
This article will discuss an option
trading strategy that offers that very
possibility. The strategy is most com-
monly known as the double calendar
spread, which, as you might guess, in-
volves establishing multiple positions
in an effort to increase the probability
of a profitable trade. Before delving
into this topic, however, let us begin
by first reviewing a basic option cal-
endar spread.

Review of the basic

calendar spread
A basic calendar spread is established
Which Trade Suits Your Objectives Better? by buying a call (or put) option of a
farther-out expiration month and sell-

The Double
ing a call (or put) option of a nearer
expiration month. Before the option

Calendar Spread
expires, its price contains an amount
referred to as time premium. This is
essentially the amount above and be-
yond any intrinsic or real in-the-mon-
Markets not going anywhere? Then take advantage of this neutral option strategy ey value that an option price contains.
that you can use in stocks, indexes, and futures contracts. In essence, it is the amount paid by
the option buyer to the seller in or-
by Jay Kaeppel der to induce the seller to assume the

O
risk of selling the option in the first
ption trading offers investors and traders a variety of unique opportuni- place. The key thing to remember is
ties that are simply not available to those who trade only the underlying that all time premium vanishes by the
stocks, futures, or indexes. Those who trade only the underlying securi- time an option expires, and time de-
Copyright (c) Technical Analysis Inc.
Stocks & Commodities V. 28:7 (50-55): The Double Calendar Spread by Jay Kaeppel

MS - Stock News Dividends: 0.7 % (2010-01-27)

Morgan Stanley Sector: Holding Offices
Leg Date Position Num Option - Strike Entry Bid/ Leg IV Vol OI Days Delta Gamma Vega Theta
cay accelerates as the
Ask Profit (%) % % %IV $/day

expiration date for a 02-16-10 Sold 18 MS MAR10 28 Call 1.09 1.07 $0.00 36.2 1464 11822 31 -49.74 -13.57 -3.2 1.9
1.11
particular option draws
02-16-10 Bought 18 MS APR10 28 Call 1.56 1.54 $0.00 36.7 275 3610 59 51.28 9.69 4.5 -1.4
nearer. 1.58
As a result of all of
this, the engine that Quote Entry Debit Profit Max Profit Max Risk Delta Gamma Vega Theta
drives the calendar Type (Cost) (Shares) Gamma/Cost Vega/Cost Theta/Cost
spread is the fact that Gamma/Cost
the nearer-term option Mid-Quote $846.00 $-0.00 $1203.82 $-846.00 27.75 -69.894 $22.00 $9.05
will give up its time 0.033 -0.083 0.026 0.011
premium via time decay Downside Breakeven Upside Breakeven Max Profit/Max Risk Max Profit/Cost
much more rapidly than 26.35 29.88 142% 142%
the farther-out month.
This affords a trader
Figure 1: standard at-the-money call calendar spread. Here the trader buys the 28 strike price call with 59 days left until
the potential to set up expiration and simultaneously sells the 28 strike price call with only 31 days left until expiration.
a trade with a range of
profitability. As long
as the underlying security remains
within or returns to that range prior 34.82
Days to expiration
34.82

to the expiration of the nearer-term

Chg: 0.66 (+2.43%)
33.41 31d -02-16-10 33.41
option, the combined option position 21d -02-26-10
32 11d -03-08-10 32
will generate a net profit. 0d -03-19-10
Figures 1 and 2 display a standard 30.59 Close: 27.82 30.59

call calendar spread using options 29.18

Open: 27.45
High: 27.93 29.18
MS stock price

on Morgan Stanley (MS). With the

Stock price
Low: 27.36
27.77 27.77
stock trading at $27.82 a share, the Date: 2010-02-16

trader buys the 28 strike price call 26.36 26.36

with 59 days left until expiration 24.95 24.95
and simultaneously sells the 28
strike price call with only 31 days 23.54 23.54

left until expiration. To be able to 22.13 22.13

compare this trade directly with 20.72 20.72
the next example, we will assume Oct 7 Oct 28 Nov 18 Dec 10 Jan 4 Jan 26 -1000 -500 0 500 1000 1500

that we are trading an 18-lot of both

Time (days) Profits ($)

calls. We will buy 18 April 28 strike Figure 2: risk curves for standard at-the-money calendar spread. The price of MS must remain
price calls and simultaneously sell within a particular range in order for this trade to make money, and a move beyond this range will result in a loss.
18 March 28 strike price calls, as
shown in Figure 1.
Figure 2 displays the risk curves for this trade. Inspecting a A trader would have to be confident in expecting MS to
set of risk curves allows you to visualize what needs to hap- stay within a fairly narrow range for the next four weeks
pen (or not happen, as the case may be) in order for a trade to be comfortable entering this trade. If the stock rises by
to make money as well as recognize where the risk(s) lie. In more than $2.06 or declines by more than $1.47, this trade
Figure 2, we can observe that MS must remain in a particular will be outside of the profit range and the trader stands to
range for this trade to make money, and that a move beyond lose money.
this range will result in a loss. As constructed in this example, Now lets take a look at a double calendar spread and
this trade has: compare the relative pros and cons.
n A maximum risk of $846
A double calendar spread
n A maximum profit potential of $1,204 Instead of establishing just one spread position, the double
n A profit range of $26.35 to $29.88. calendar spread establishes two separate positions but treats
them as one for the purpose of analyzing the profit and loss
potential. Once again looking at Morgan Stanley, for the
Only a thorough comparison can allow purposes of this example instead of just establishing one
you to decide which trade suits your spread at one strike price, we will establish two positions at
own profit-to-risk goals. two separate strike prices:

Copyright (c) Technical Analysis Inc.

 Stocks & Commodities V. 28:7 (50-55): The Double Calendar Spread by Jay Kaeppel
OPTIONS
MS - Stock News Dividends: 0.7 % (2010-01-27)
Morgan Stanley Sector: Holding Offices
Leg Date Position Num Option - Strike Entry Bid/ Leg IV Vol OI Days Delta Gamma Vega Theta
Ask Profit (%) % % %IV $/day
the previous standard
MS MAR10 30 Call
calendar spread that we
02-16-10 Sold 11 0.36 0.34 $0.00 33.6 682 7372 31 -23.63 -11.30 -2.5 1.4
0.37
02-16-10 Bought 11 MS APR10 30 Call 0.73 0.72 $11.00 34.5 1009 9578 59 31.82 9.25 4.0 -1.2
analyzed earlier, we will
0.76 trade an 11-lot of each
02-16-10 Sold 11 MS MAR10 26 Put 0.57 0.55 $11.00 40.6 229 2986 31 26.33 -9.91 -2.6 1.7 option so our total risk
0.58 on this trade is $836,
02-16-10 Bought 11 MS APR10 26 Put 0.96 0.95 $0.00 40.0 296 5807 59 -30.68 7.84 3.9 -1.3 roughly equivalent to
0.97 the dollar risk in the
earlier standard calendar
Quote Entry Debit Profit Max Profit Max Risk Delta Gamma Vega Theta spread. The particulars
Type (Cost) (Shares) Gamma/Cost Vega/Cost Theta/Cost of this position and the
Delta/Cost
risk curves appear in
Figures 3 and 4. As estab-
Mid-Quote $836.00 $22.00 $580.42 $-836.00 42.27 -45.239 $30.46 $6.55
0.051 -0.054 0.036 0.0078
lished here, this double
Downside Breakeven Upside Breakeven Max Profit/Max Risk Max Profit/Cost calendar trade has:
25.09 31.12 69% 69%
n A maximum risk
of $836
FIGURE 3: THE FOUR LEGS OF A DOUBLE CALENDAR SPREAD. The four legs are long a call, short a call, long a put, and short a put.
n A maximum profit
potential of $580
34.82 Days to expiration 34.82
Chg: 0.66 (+.2.43%)
n A profit range of $25.09
31d -02-16-10
33.42 33.42
21d -02-26-10
32.02 11d -03-08-10 32.02
to $31.12.
0d -03-19-10
30.62 Close: 27.82 30.62
Open: 27.45 In Figure 4, we see the differences
MS stock price

29.22 High: 27.93 29.22

and similarities of this trade to the
Stock price

Low: 27.36
27.82 Date: 2010-02-16 27.82 earlier basic calendar spread. For
26.42 26.42
both trades, MS must remain within
a range for the trade to profit. In addi-
25.02 25.02 tion, while the basic calendar spread
23.62 23.62 has a profit spike in the middle of the
22.22 22.22
risk curve and a slightly narrower
profit range, the double calendar
20.82
Oct 7 Oct 28 Nov 18 Dec 10 Jan 4 Jan 26 -1000 -500 0 500
20.82
1000 spread has two lesser spikes: a sag
Time (days) Profits ($) in the middle and a wider range of
profit.
FIGURE 4: RISK CURVES FOR MS DOUBLE CALENDAR SPREAD. While the basic calendar spread has a profit
spike in the middle of the risk curve and a slightly narrower profit range, the double calendar spread has two lesser
Lets take a closer look at the dif-
spikes: a sag in the middle and a wider range of profit. ferences and similarities between
these two trades with an eye toward deciding which trade we
a An out-of-the-money might prefer based on our own objectives.
call calendar spread
at a strike price above Comparing the two trades
the current price of Now lets look at the most relevant aspects of these two trades.
the stocks, and As with most things in life, there are tradeoffs between these
two positions. While the total dollar risk is roughly the same,
b An out-of-the-money each has a particular advantage over the other:
put calendar spread n The standard at-the-money calendar spread has a
at a strike price be- maximum profit potential of 142% versus the double
low the current price calendar spread, which has only a 69% maximum
of the stock. profit potential. At first blush, this appears to be a huge
advantage for the basic calendar spread. One thing to
To establish this position, we will buy the April/March 30 remember, however, is that this 142% maximum profit
call spread at $0.37 and we will buy the April/March 26 put potential would only be realized if the price of Morgan
spread at $0.39. Stanley is at exactly $28 a share at the close on the day
To be able to compare this double calendar spread to that the shorter-term March option expired. So while
Copyright (c) Technical Analysis Inc.
Stocks & Commodities V. 28:7 (50-55): The Double Calendar Spread by Jay Kaeppel
Probability Calculator There is no guarantee
Stock Symbol ms
that trading a double
Future stock price at each standard deviation

Stock Price 27.82 +1 -1

calendar spread will
Past Stock Days 20
31.0 24.9 generate better results
Stock Price Band None
+2 -2 than a basic spread.
34.6 22.4
Rate of Return
Stock Predicted 0 % +3
38.6
-3
20.1
the prospect of earning 142% in
just 31 days is appealing, the prob-
Rate of Return Stock Mean at Future Date
27.82
Future Days Probability of future stock price ability of realizing the maximum
Probabilities 31 Ending below Ever touching profit potential is quite low. Of big-
ger concern is the probability of
Computed At Future Date lowest target lowest target
(MM/DD/YY) 03 / 19 / 10 32.8 % 63.4 %

Ending between Never touching

generating any kind of a profit at
100d SV User Defined the two targets either target all.
20d SV 6d SV 43.2 % 17.6 %
Volatility Type
7-30d IV 30-60d IV Ending above Ever touching n The standard at-the-money calen-
dar spread example has breakeven
60-90d IV >90d IV higher target higher target
24.0 % 49.6 %

Volatility 37.484 % points of $26.35 and $29.88. Ac-

Annual Interest 1 %
cording to the probability calcu-
Rate 43% probability of profit lations displayed in Figure 5, the
Annual Dividend 0.7 % probability of the stock ending be-
Rate
First Price Target 29.88 tween these two targets is 43.2%.
Second Price 26.35
Mathematically speaking, this trade
Target has only a 43% probability of mak-
ing money. From this we can infer
FIGURE 5: PROBABILITY CALCULATIONS FOR BASIC CALENDAR SPREAD EXAMPLE. The probability that at the time this trade is estab-
of the stock ending between $26.35 and $29.88 is 43.2%. At the time this trade is established, it has a 57% lished, it essentially has a 57%
chance of losing money. chance of losing money.

n The double calendar spread exam-

Probability Calculator ple has somewhat wider breakeven
points of $25.09 and $31.12. Ac-
Stock Symbol ms Future stock price at each standard deviation cording to the probability calcu-
Stock Price 27.82 +1 -1 lations displayed in Figure 6, the
Past Stock Days 20
31.0 24.9
probability of the stock ending be-
Stock Price Band None
+2 -2 tween these two targets is 67.4%.
Rate of Return
34.6 22.4
Mathematically speaking, this trade
Stock Predicted 0 % +3 -3 has a much greater probability of
Rate of Return Stock Mean at Future Date 38.6 20.1
making some profit versus the stan-
27.82
Future Days Probability of future stock price dard calendar spread.
Probabilities 31 Ending below Ever touching
Computed At Future Date lowest target lowest target So one question you must answer be-
fore entering a trade is, Am I seeking
(MM/DD/YY) 03 / 19 / 10 18.6 % 36.1 %

100d SV User Defined

Ending between
the two targets
Never touching
either target maximum profit or the highest probabil-
20d SV 6d SV 67.4 % 52.5 % ity of making a profit of any size? If
Volatility Type
7-30d IV 30-60d IV Ending above Ever touching the answer is the latter, then the double
calendar might make more sense, as
60-90d IV >90d IV higher target higher target
14.0 % 28.9 %

Volatility 37.484 % it enjoys a much higher probability of

Annual Interest 1 %
profit (67%) versus the standard calendar
Rate 67% probability of profit spread (43%).
Annual Dividend 0.7 %
Rate
First Price Target 31.12 Profit or high probability?
Second Price 25.09
There is no guarantee that trading a dou-
Target ble calendar spread on a given security
will necessarily generate better results
FIGURE 6: PROBABILITY CALCULATIONS FOR DOUBLE CALENDAR SPREAD. The probability of the stock than a basic calendar spread using op-
price ending between $25.09 and $31.12 is 67.4%. This means this trade has a much greater probability of tions of the same security. However, as
making some profit versus the standard calendar spread. the simple examples included here illus-
trate, there is the possibility that estab-

Copyright (c) Technical Analysis Inc.

Stocks & Commodities V. 28:7 (50-55): The Double Calendar Spread by Jay Kaeppel
OPTIONS

lishing a double calendar spread may offer a higher initial
probability of profit.
In the end, only a thorough comparison of the relative
pros and cons of two actual proposed positions can allow
you to decide which trade best suits your own profit-to-risk
and probability-of-profit goals.
Jay Kaeppel, an independent trader, is the author of Sea-
sonal Stock Market Trends and writes a weekly column
titled Kaeppels Corner for Optionetics.com. He may be
reached at the discussion boards at Optionetics.com.
Suggested reading
Gopalakrishnan, Jayanthi, and Bruce R. Faber [2009]. Jay
Kaeppel On Trading Futures And Options And Gold And
Sectors, interview, Technical Analysis of Stocks &
Commodities, Volume 27: November.
Kaeppel, Jay [2010]. Introducing The Modidor Spread,
Technical Analysis of Stocks & Commodities, Volume
28: May.
_____ [2009]. Seasonal Stock Market Trends, John Wiley
& Sons.
S&C

Copyright (c) Technical Analysis Inc.

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