Long Put Calendar Spread
Outlook: Expecting minimal price movement; possible bearish skew

The long put calendar spread is a strategy designed to profit from a near-total coma in the underlying shares. Employing two different put options spread across two calendar months -- with a single strike in common -- the trade derives its value entirely from changes in the options' premiums. When the shorter-term option hits its expiration date, both legs of the trade are closed out, ideally while the longer-term put still has a healthy dose of time value intact.

Since it's impossible to determine in advance what your breakeven point and maximum profit will be, this is a strategy best reserved for very experienced speculators. To learn how the long put calendar spread works, let's check out a hypothetical trade.

Entering the Trade

Stock XYZ is languishing near the $70 mark, and you expect this round-number level will continue to act as a magnet for the shares during the near term. You initiate a long put calendar spread by selling to open a front-month 70-strike put at the bid price of 1.00, and simultaneously buying to open a back-month 70-strike put at the ask price of 1.60.

You spent 1.60 to purchase the longer-term put and collected 1.00 on the sale of the shorter-term put, so your initial net debit is 0.60. Multiplied by 100 shares per contract, you've entered the spread at a net cost of $60.

Potential Gains

In the best of all possible worlds, XYZ will remain stuck to the $70 level through front-month expiration. In this scenario, your sold put could be left to expire worthless, while your purchased put could be sold to close at a price of 1.24. You netted 1.24 for exiting the trade, and spent 0.60 to enter -- so your profit on this spread amounts to 0.64. Given 100 shares per contract, your gain is $64.

While it's impossible to predict with any accuracy how much your purchased put will be worth at the expiration of your shorter-term option, remember that your maximum gain on a long put calendar spread is equal to the net credit you receive upon closing both puts, less the net debit you paid to enter the spread.

It's also possible to collect smaller profits, though you can't calculate your breakeven until after you've entered the spread. Generally speaking, however, you need your net credit upon unwinding the trade to equal your initial net debit in order to break even.

Potential Losses

Your maximum possible loss on the long put calendar spread is capped to your initial net debit of 0.60, or $60. Even if XYZ plummets to zero and you're assigned on the short put, your obligations can be met by exercising the longer-term put. Meanwhile, if the stock should rally, the value of both options will eventually dwindle to zero.

Volatility Impact

Since you're short a front-month option and long a back-month option -- and since the spread relies upon stagnant price action in the shares -- you'd like to see implied volatility remain fairly stable when you first initiate the long put calendar spread. However, once expiration is imminent for the shorter-term put, it should benefit you if implied volatility edges higher. This won't have much impact on the soon-to-expire sold option, but the longer-term option should gain value, thereby increasing the amount you stand to collect upon exiting the trade.

Other Considerations

You can modify the long put calendar spread by playing with different time spans. For example, you might prefer to space your options three months apart rather than one month. If so, you can continually roll out your short option to the next series upon expiration, thereby increasing the credit you receive as a put seller.