How does a calendar spread profit from time decay?

Question

AcadiFi · Accepted Answer

Yes, that's a long calendar spread (also called a time spread). You sell a near-term option and buy a longer-dated option at the same strike. For Tidewater Rail at $55:

- Sell 1 weekly $55 call for $0.80 (expires in 7 days)
- Buy 1 monthly $55 call for $2.10 (expires in 35 days)
- Net debit: $1.30

The mechanics exploit differential theta decay. Near-term options lose time value much faster than longer-dated options — theta is roughly proportional to 1/√(T). At day 7, the weekly option has fully decayed (or been bought back cheaply), while the monthly option has only lost about a third of its time value. Your net position retains most of the long call's value while collecting the full short premium.

Max profit occurs if Tidewater sits near $55 at the weekly expiration — the short decays to zero while the long retains substantial extrinsic value. A large move in either direction damages the position because both options approach intrinsic value and the time-value differential evaporates.

Key risks: (1) large price moves (calendar is short gamma near the strike), (2) a collapse in implied volatility of the longer-dated option (calendar is long vega), and (3) early assignment if the short goes ITM before ex-dividend. On the CFA exam, calendars illustrate how theta and vega can be separated across two legs to construct targeted volatility exposures.

How does a calendar spread profit from time decay?

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