Taking advantage of time decay is a key component to option trading success. Calendar spreads are one of the best and most direct methods for taking advantage of time decay. Calendar spreads are price neutral by design, as they are most efficiently created using at-the-money option contracts. Before short-dated options were introduced, calendar spread opportunities did exist. Now, however, with an at-the-money option consistently expiring every week, the calendar spreading opportunities and the flexibility around trading these spreads has increased tremendously. In addition, now that there are short-dated options consistently available for trading it is possible to buy a long-dated option with the intent of selling more than one short-dated option over the life of the long-dated options. The goal behind this sort of trading is for the short options to expire slightly out-of-the-money and the long option to have enough value to be sold at a net profit.
A calendar spread consists of a long and short option position. The strike price and type of option (call or put) is the same. The difference between the two contracts is the expiration date. Typically the short contract expires before the long-dated contract. First, consider the more common neutral example of a calendar spread. With XYZ trading at 35.00 a couple of examples are: