Calendar Spreads
Calendar spreads are stability spreads, meaning that they profit most when the underlying is stable and lose when the underlying becomes very volatile. The profit profile for a calendar spreads looks like a tent, or an inverted “V.”
The greatest profit occurs when the underlying is at precisely the strike price on the expiration of the short-term option. At that strike price the short-term option expires worthless, so you collect the entire premium for it and do not have to buy it back; a lower price does not benefit the short position, but subtracts from the value of the long position, while a higher price at expiration means a larger value for the long position but a positive price to buy back the short position.
Of course changes in implied volatility affect the value of the long at expiration, and also the value of the short should the underlying close above the strike price. There are ways to estimate these effects, which we will cover in future commentaries.