Take Advantage of Disparities in Option Prices.

Calendar Option Spread : A Quick Introduction

The Calendar Option Spread is initiated by purchasing a deferred month option and selling a closer-to-expiration option. The advantage of this position is the steep time decay that close-to-the-money options undergo. This in itself is a substantial advantage to an investor; however, there are additional situations when this trade turns the odds overwhelmingly in favor of the option strategist.

Option volatility for the closer-to-expiration months can often be trading at substantially higher levels than the deferred option. This happens in volatile markets, as there is an increased demand for these "more active" options for speculation and hedging. Often we find that the deferred month options are "forgotten" and trading at volatility levels 50% or more below the active front month option.

This can create some significant advantages for a trader such as:

1. the trader can take advantage of the undervaluation of the deferred month option contract,
2. the overpricing of the close-to-expiration options; and
3. the rapid time decay of the close-to-expiration options.

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