Neutral - Calendar Spread

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A calendar spread is when you buy an option with a longer time to expiration (such as a LEAP) and you sell an option with the same strike price and underlying stock with a shorter expiration.  This can be done with either calls or puts, but you have to either buy and sell puts or calls, you cannot buy puts and sell calls, or visa versa.  The basic idea of a calendar spread is to profit on the different rates of decay on the two options: The long-term option you buying will decay, or decline in value, at a rate slower than a short-term option, all else being equal.

Calendar spreads are also referred to as horizontal spreads because the spread is based on time.  They're also called a vertical spread because option quotes are listed top to bottom, and the spread involves buying near the bottom and selling near the top.

Example: QLogic 12-month $50 calls sell for $5.30, while 1-month $50 calls sell for $.85.  If the stock stays flat, the 1-month calls will decay $.85 in 30 days, while the 12-month calls will decay $.44 ($5.30 / 12 months).  Thus, if you buy the 12-month calls and sell the 1-month calls, you make $.44 per share.

The above example assumes that the stock stays flat, which is rarely ever the case in the real world.  If the stock fluctuates wildly in price, you are likely to lose money on the spread.  That is why the Calendar Spread is risky.  It is best to do this spread on stocks you think will stay relatively flat in price.