If you expect a drop in implied volatility, you might want to consider the short put calendar spread strategy. In order to achieve this, you sell a longer-term put while buying a shorter-term put at the same strike price. This approach can give you a good position when the stock price swings away from your chosen strike price as the long put’s expiration nears. Today we’ll guide you through the process of executing a short put calendar spread, including managing risk and maximizing profits.
Key takeaways
- A short put calendar spread is a strategy in which you sell a longer-term put and buy a shorter-term put with the same strike price.
- You can open a short-put calendar spread to benefit from a large movement in the underlying stock price combined with an expected drop in implied volatility.
- The short put calendar spread profits most when the stock price significantly diverges from the strike price by the expiration date of the long put.
What Is a Short Put Calendar Spread?
A short put calendar spread works pretty much like a regular short calendar spread with calls, except for the fact it uses puts, making it an appealing choice for traders eyeing volatility without a strong directional bias. Here is how it works:
- You sell a long term put
- You buy a short term put at the same strike price.
Let’s say, for instance, that you expect an implied volatility drop from a stock like Adobe (ADBE), which will release its earnings report in a few weeks. You know that ADBE is among the companies benefiting from the growth in AI technology (think, for instance, to the applications for image elaboration in Photoshop), so the stock might experience some sharp swings depending on the guidance of its earnings report.
Rather than buying puts outright, you want to take advantage of volatility by using a spread involving puts in the short-term while selling another longer-dated put. So, with ADBE trading at $483.31, you could sell a three-month $490 put and buy a one-month $490 put, obtaining this P&L profile:
This is a pretty easy chart to read:
- Your losses will hit a maximum point with the stock trading at $490
- Your profits will be limited to $540 on the right and to $560 on the left
A more detailed example will help us understand how this trade works, as we tell you in the section below.
A Short Put Calendar Spread Example
We already shared a few important details with the ADBE example, but let us now be more specific and see how a short put calendar spread can be applied to another real-world scenario. Let’s say we look at MicroStrategy (MSTR), a company well-known for its significant Bitcoin (BTC) holdings.
MicroStrategy has made headlines year after year for accumulating a vast amount of Bitcoin using the Dollar Cost Averaging (DCA) investment method. With the latest Bitcoin halving event, market watchers could expect substantial price movements in BTC (obviously, we’re not here to give you advice on the crypto market, this is just theoretical reasoning). Given MSTR’s high correlation with Bitcoin prices over the years, any major shift in BTC is likely to have an impact on MSTR’s stock price.
However, macroeconomic variables, such as a cooling off of US core inflation after a period of sustained increase, present a case where the crypto market, and by extension MSTR, could see downward movement. Thus, if you conclude that BTC will experience a significant price change in the coming months, you may also assume that MSTR’s implied volatility will drop, so a short put calendar spread becomes an attractive strategy.
Imagine MSTR is currently trading at $1,462. In this scenario, you could look for a strategy on an options screener and choose to do the following:
- You sell a three-month $1,470 put
- You buy a one-month $1,470 put.
This creates a position that benefits from an IV drop rather than the direction of the market movement. Most trading platforms will show the Profit and Loss (P&L) profile based exclusively on the expiration of the shorter-term put, as you see here below:
It’s crucial to understand that your potential losses max out should MSTR’s stock price hover around the $1,470 strike price at the expiration of the long put. Conversely, your profit potential is asymmetric. If MSTR’s price dips below $1,210, your strategy could net you just over $10,000. On the other hand, should MSTR’s price surge above $1,921, your earnings would still be impressive (up to more than $9,000).
Now, if you are setting up a short put calendar spread, you believe that MSTR’s stock is more likely to fall than rise, as you can understand from the outcomes above. However, this strategy is not about betting on a specific direction; it’s about preparing for a sudden IV drop coupled with a strong price movement in the underlying stock. By selling a longer-term put and buying a shorter-term one at the same strike price, you’re essentially insuring your trade against drastic movements in either direction.
MicroStrategy’s unique position in the market makes it an ideal candidate for the short put calendar spread. Its stock price is significantly influenced by the movements of Bitcoin (an asset with historically high volatility), making it susceptible to large swings that are perfect for a short put calendar spread.
In general, you do not need to find such particular cases to create this type of trade. Like we said with ADBE, a more common earnings event can be more than enough to justify the use of this strategy. This was just a way to show you how flexible the strategy is. Some websites label the short put calendar spread as a good idea for trading earnings, but keep in mind that you may not want to limit yourself exclusively to earnings.
Note that you could also close the short-term put while keeping the longer-term put open and opening a new short-term put at a different strike price. This idea would quickly turn into an income trade, but that’s a different concept for another time.
When Is a Short Put Calendar Spread a Good Idea?
A short put calendar spread becomes a smart play when you’re expecting big moves in a stock’s price but can’t pin down whether it’ll move up or down. Picture this: A company is about to announce earnings, launch a new product, or hear back from the regulator on a critical matter.
Any of these events could lead to massive swings in the stock price—good news might send it soaring, while bad news could crash it down. The catch? If the announcement doesn’t stir the pot as much as you thought, you might see the spread’s price go up, and your wallet feel a bit lighter.
Remember, options prices—and by extension, put calendar spreads—reflect what traders think will happen to the stock price before it expires. In simpler terms, if you’re selling a calendar spread, you’re betting against the crowd, believing the stock will zag when others expect it to zig, moving far enough in either direction to pass your break-even point.
This logic holds especially true around earnings reports or similar big news days, which are circled in red on every trader’s calendar.
Consider that, as we approach earnings, an option’s implied volatility tends to move up. Higher implied volatility translates to wider breakeven margins—you need the stock to make a bigger leap or dip to hit your profit zone. When this happens, usually, the options IV will drop, benefitting your position.
Some Tips to Handle Risks (and Something to Know about Potential Profits)
In the table below, we summarize the crucial aspects of managing risks and understanding the potential profits with a short put calendar spread:
Maximum Profit
The maximum profit you can aim for with the put calendar spread is essentially the net credit received minus any commissions. This peak profit materializes when the stock price significantly diverges from the strike price at the long put’s expiration—either soaring high above or dropping well below. Such movement renders the price difference between the two puts negligible, allowing you to pocket the initial spread as income.
Maximum Risk
On the other side, the maximum risk looms if the long put expires worthless while the short put remains active, potentially leaving you exposed. This risk is heightened as the expiration date of the long put nears, especially if the stock price meets the strike price right at the long put’s expiration. That scenario spells out the maximum loss due to the short put holding the most time value.
Uncertainty of Breakeven Points
Breakeven points are a bit trickier, sitting both above and below the strike price. They hinge on the moment when the short put’s time value matches the original spread cost. However, given volatility’s influence on time value, finding the exact breakeven stock prices can be a very complex operation.
Can You Avoid Early Assignment?
If you’ve already had to face early assignments in the past, you may be familiar with the slight panic that ensues. In a short put calendar spread, the long put isn’t at risk of early assignment, but the short put is—especially around dividend dates.
Puts deep in the money might get assigned early if their time value falls below the upcoming dividend. To dodge this, you have two moves before the assignment happens. One, close the spread by handling both puts. Two, buy back the short put and keep the long one.
Ended up with early assignment and an unintended long stock position? Don’t sweat it; you can either offload the shares and potentially sell the long put, or just exercise the long put to sell the stock, ideally choosing the option that saves any remaining time value.
Remember, exercising the long put means losing any time value, which isn’t ideal unless the long put’s about to expire. Also, watch out for the extra day between buying and selling the stock—it might add unexpected fees to your trade.
How Will Time Affect Your Position?
Time decay is a major aspect to consider every time you buy or sell an option. Known as “theta,” it measures how much the value of an option drops as it gets closer to expiration. For a short calendar spread with puts, where you’re juggling both a short and long put, time plays a tricky game.
Typically, the short option (sold) enjoys the benefit of time decay, adding value as the clock ticks. However, the long put (bought) loses money over time due to this same decay, making the spread’s success heavily reliant on the stock’s movement.
If the stock hovers near the strike price, time decay erodes your position, with a net negative theta scenario. But if the stock moves significantly above or below the strike, time starts working slightly in your favor with this put calendar spread, minimizing the decay’s impact on your long put while the short put continues to benefit as expiration approaches.
