A double calendar spread is a trading strategy used to exploit time differences in the volatility of an underlying asset. While this spread is fairly advanced, it’s also relatively easy to understand once you’re able to look at its inner workings.
Here’s what you need to know about double calendar spreads and how they are used in options trading.
What Is a Double Calendar Spread and How Does it Work?
To understand the workings of the double calendar spread, you first have to know how an ordinary calendar spread works.
This type of spread involves opening two positions on the same underlying asset simultaneously, but with two different delivery months.
A typical calendar spread involves a near-term sell option with a buy option in a later month.
Importantly, the two options that make up the spread will also share the same type and strike price. Thus, a single calendar spread might look as follows:
- Sell 50 ABC June 20 strike calls
- Buy 50 ABC July 20 strike calls
Under ideal conditions, the near-term option will expire out of the money, allowing the trader to capture the premium from it. After the first option expires, the long-term option stands on its own.
From that point on, the long-term option can have a potentially unlimited profit, provided it moves in the direction the trader predicted when constructing the spread. In this sense, the premium from the short-term option offsets the cost of the long-term option, reducing the overall cost of the trade.
The same basic structure is used in a double calendar spread. When the spread is doubled, however, each delivery month will include both a call and a put option, as opposed to the single option type deployed in a standard calendar spread.
If the strike prices in each leg of the spread are the same, each month’s options effectively form a straddle.
Alternatively, the spread can be constructed with each leg at a different strike price, in which case each month’s options take on the characteristics of a strangle strategy.
An example double calendar spread of the latter type might look as follows:
- Sell 20 ABC October 35 strike calls
- Sell 20 ABC October 30 strike puts
- Buy 20 ABC November 35 strike calls
- Buy 20 ABC November 30 strike puts
Why Trade This Spread?
The point of all calendar spreads is to profit from increases in implied volatility over time.
When a particular security is expected to experience low volatility in the short term but higher volatility during a later time period, a calendar spread can be quite useful. For this reason, a calendar or double calendar spread may be preferred when an election, earnings report or other news event is likely to increase an asset’s volatility after a certain date.
Because a double calendar spread can have two legs that form a strangle in each month, it offers two areas of maximum profitability, with one peak at either of the two strike prices.
This contrasts with the strictly neutral single calendar spread, in which profits are maximized when the price of the underlying asset is at or very near to the strike price of the options.
As a result, there is more potential for profit across a range of prices when using a double calendar spread, while the potential downside remains well defined.
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Building a Double Calendar Spread
To build a double calendar spread, it’s important to first select an appropriate underlying asset.
Generally, you’re looking for a security that you believe will be stable in the near-term, then trend moderately bullish or bearish on a longer time scale. After that, you will have to decide on your expiration dates.
Most traders construct their double calendar spreads with a gap of one month between the first and second expiration dates, though this may vary depending on your market expectations.
It’s also important to understand that calendar spreads can be adjusted after they have been placed. For instance, market movements may make it profitable to buy long-term options at a higher or lower strike price after your initial purchase.
As with any options trading strategy, careful risk management is important when trading double calendar spreads.
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Understanding the Risks
While double calendar spreads can offer reasonably good profits and defined, manageable downsides, they are not without their risks.
Even with a straddle or a strangle in each of the two delivery months, market conditions can turn against your position and prevent you from realizing the gains you expected.
Likewise, if the event you’re expecting to produce enhanced volatility later on fails to do so, you may find yourself holding options without much in the line of upside.
For these reasons, calendar and particularly double calendar spreads are usually recommended for reasonably experienced options traders.
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How to Place a Double Calendar Spread
To put a double calendar spread in place, you should start by opening an account with a leading options trading broker such as tastyworks.
Brokers that understand the risks and rewards of complex options strategies are in the best position to ensure your success when constructing spreads.
Often, the resources, tools and research materials a broker makes available to you are instrumental in helping you execute profitable trades.
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