What it means
Options lose value as they approach expiry, a process known as time decay. A short-dated option loses value faster than a long-dated one, and a put calendar is built to benefit from that difference.
The trader sells the quickly decaying near-term put and buys the slowly decaying longer-term put. Because the longer-dated option is worth more than the shorter-dated one at the same strike, the position costs money to set up.
This cost, called a net debit, is also the most the trader can normally lose if the position is closed when the near-term put expires. That limited downside makes the strategy attractive to people who want defined risk.
The best result occurs when the asset price is close to the strike price when the near-term put expires. The short put then expires worthless or nearly worthless, so the trader keeps the premium collected, while the longer-dated put still holds a good deal of value.
The trader can then sell the long put, or sell another short-dated put against it and repeat the process. The position also depends on volatility, meaning how widely the market expects prices to swing.
A rise in expected volatility generally increases the value of the longer-dated put more than the shorter one, which helps the position. A fall in volatility works against it.
Large price moves in either direction hurt. If the asset price falls far below the strike, both puts move deep into the money and their values converge, so the spread narrows.
If the price rises far above the strike, both puts become nearly worthless and the trader loses most of the debit. A nuance is that the trader must manage the position actively.
If the short put is exercised early by its holder, the trader may be obliged to buy the asset, and the long put then needs to be adjusted. This is why many practitioners close or roll the position before expiry rather than letting it run.
In practice
Real-world examples.
Example
A trader expects a quiet month for a large retailer's share price, currently at $100. She sets up a put calendar at the $100 strike. When the shares drift between $99 and $101 until the near-term put expires, she collects a modest profit.
Example
A fund manager already holds a long-dated put as a hedge and wants to reduce its cost. She sells a short-dated put at the same strike against it, creating a calendar spread. The income from the short put offsets part of the cost of the hedge.
Example
An options trader anticipates a rise in volatility ahead of a company's earnings announcement. He buys the longer-dated put and sells the near-term one at the same strike. If implied volatility rises as expected, the longer-dated put gains more in value than the short put, producing a profit even if the share price barely moves.
Formula
Calculation
Net debit = premium paid for the long-dated put - premium received for the short-dated put
Suppose a trader sells a 30-day put with a strike price of $100 for $2.00 per share and buys a 90-day put at the same strike for $4.50 per share. The net debit is 4.50 - 2.00 = $2.50 per share, which is 2.50 x 100 = $250 per contract of 100 shares. If the share price is $100 when the 30-day put expires, that put expires worthless and the trader keeps the $2.00. If the 90-day put is then worth $3.50, the total result is a gain of 2.00 - (4.50 - 3.50) = $1.00 per share, or $100 per contract.Case study
Seen in the real world.
Linden Capital is an illustrative, fictional small trading firm that expected a calm period for a mid-sized energy company's shares, then priced at $60. The portfolio manager built a put calendar with a $60 strike, selling a 4-week put and buying a 12-week put. The net debit was $1.80 per share on 1,000 shares, or a total of $1,800.
Four weeks later, the shares closed at $60.50, so the short put expired worthless and the firm kept its premium. The long put was still valued at $3.20, which, together with the premium collected earlier, produced a net profit on the position. The firm sold the long put for a gain.
In a second illustrative attempt, an unexpected announcement caused the shares to fall 15%. Both puts moved deep into the money, the spread collapsed, and the firm lost close to the full debit. The lesson was that a put calendar rewards stillness and punishes large moves, so position size should reflect the maximum loss.
Watch out
Common mistakes.
- Choosing a strike far from the current price, which makes it unlikely that the asset will finish near the strike when the short put expires.
- Ignoring the effect of volatility, since a fall in implied volatility can reduce the value of the long-dated put even if the share price does not move.
- Assuming the maximum loss is zero because one option is sold, when the trader can lose the entire net debit.
Questions
People also ask.
What is the maximum loss on a put calendar?
When the position is closed at the near-term expiry, the maximum loss is generally limited to the net debit paid, although early exercise and later management can complicate this.
How does a put calendar differ from a call calendar?
The structure is the same, but a put calendar uses puts and so tends to be used when the trader has a neutral or slightly bearish view, while a call calendar uses calls.
When is the best time to enter a put calendar?
Traders often prefer to enter when near-term implied volatility is high compared with longer-dated volatility, since this lets them sell the short put at a rich price.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%Related