Twin Tops: How and When to Set Up a Double Calendar

When you trade basic options strategies—individual calls and puts, vertical spreads, and even straddles and strangles—volatility (vol) and time decay (theta) are locked in a tug of war. Got a long position? Even as vol ticks higher, theta is constantly pulling the other way. And if you’re short, you like that theta tailwind, but you know that a rise in vol could act as a counterforce.

Want to burn some theta while maintaining long vol exposure (vega)? That’s where time spreads come in. And they come in a couple varieties: There’s the basic calendar spread and its more exotic cousin, the double-calendar spread. These are debit spreads. Premium is paid up front, and your max loss is that premium, assuming you close it out on time (more on that later).

How Many Peaks—One or Two?

Think of a calendar spread as the sale of a short-term option with the purchase of a longer-term option of the same type and strike, say the FAHN Jul–Aug 140 call calendar spread. As time passes, the shorter-term July option you sold should decay faster than the longer-dated August call you bought. Assuming FAHN stays within a range around 140, as expiration of the front leg approaches, the risk profile begins to form a peak centered at the 140 strike (see the risk profile in figure 1).

The 140 is the high watermark, and the profit potential begins to fade as soon as FAHN deviates from 140. By the time it’s moved $5 one way or the other, you’re below the break-even point. If that’s your objective, great. But if you’re looking to spread out that risk, you might consider a double calendar.

So, instead of a single calendar at the 140 strike, say you set up two calendars—one using the Jul and Aug 135 put strikes, another using the Jul and Aug 145 call strikes. That’s a double calendar (see figure 2).

Whether you choose a single or double calendar, your objective is the same. If FAHN stays in a range, the accelerated theta of the front-month strike should work in your favor. But if you think an outsize move in FAHN could pull vol out of the doldrums, the long vega of calendars and double calendars might give your profit and loss a boost, or at least a head start, even if FAHN moves away from the peaks. 

Want to check the potential effects of a vol move? Fire up the thinkorswim platform. After loading up your trade under the Analyze tab > Risk Profile, switch the simulator from +1 @ Expiration to +1 @ Vol Step. You can check the possible effects of one (or several) up (or down) move in vol (see figure 3). 

If you’re having trouble visualizing the dynamics of a double calendar, think of it this way: It’s the combination of two strangles—a short-dated short strangle and a longer-dated long strangle. The short one aims to maximize theta while the long one aims to give you long vega exposure. 

The two-strangle view should help punctuate the number one rule of double calendars: Decide your next move—and act on it—before the front legs expire. Otherwise, you’re left with just a long strangle—long vega, but no theta tailwind behind you. That would run counter to your initial objective of burning theta while you waited for that vega pop. Once the theta stops burning, it’s time to assess.

Strategy and Risk with Double Calendars

With four legs spread over two expiration dates, you’ll encounter more moving parts versus your typical options strategy. Keep all this in mind as you set and monitor the double calendar.

Strike selection. If you’ve ever spent an afternoon in the orange juice aisle, you know a wide set of choices can be daunting. With double calendars, there’s really just one rule: The further apart you set your strikes, the wider you spread out your risk. Yet, in so doing, you also deepen the valley between peaks, sometimes to the point the position behaves like two separate calendars. So, it really depends on how much you expect FAHN to wiggle. Remember: If you think FAHN is set to stay put, the single calendar (with a single peak) might be a better choice.  

Pre-expiration tickler. When an out-of-the-money option expires, aside from that line item on your statement, it goes away with little fanfare. But with calendars, double calendars, and other time spreads, you need to decide what to do with the long leg(s). With a double calendar, once the short options expire, you’re left with a long strangle—and that’s a different risk profile. Actually, once the front legs approach zero, there’s little theta left in the spread. You might even have more daily theta in the back legs. That’s when you know it’s time to move on.   

The roll decision. Do you close out the long legs as the shorts expire, or do you roll the position to another spread? And if FAHN has moved a bit during the life of the spread, do you reset the strikes around the current price? Depending on your current outlook—including vol—you might do that. Some traders like to set the long legs a couple months beyond the expiration of the short legs. When the front month expires, assuming FAHN is still within the strike range, they’ll sell another short-term strangle and repeat the process. Keep in mind that multi-leg and rolling options strategies can entail additional transaction costs, including multiple commissions and contract fees, which may impact any potential return.

One final note: Vol can drift lower even while FAHN makes an outsize move beyond your strikes. Though it’s a worst-case scenario, your loss is still limited to the price you paid for the spread (plus transaction costs). It’s about giving yourself good odds and keeping within your risk parameters.

If you like the idea of spreading out your risk and think vol could be on the upswing but you like the idea of a theta tailwind, you might want the double.