A calendar spread that involves the purchase of an option with a further expiration and the sale of an option with the same strike price and a closer expiration. For example, the stock of XYZ company is trading at $50 in April. An investor may establish a short calendar spread by buying XYZ June 50 calls and selling XYZ July 50 calls. However, an investor putting on this trade would receive a net credit. Assuming the June and July calls cost $5 and $6.5 respectively, the spread value (the return) of this position is, then, $1.5. The calendar spread would pay off if the underlying makes a significant move in either direction so that the time values of both options would rapidly deteriorate.

When the underlying price remains relatively unchanged as the near-month expiration approaches, the calendar spread would lose value in case the near-month option loses its time value at a faster pace than the far-month option. Assume the investor is now in May (i.e., one month before the June expiration), the market prices of the underlying options might be $2 and $4 respectively. As a result, the return from the short calendar spread is now $2.

Suppose the underlying stock moved downside to $30 in May, and as a result the market prices of the underlying options might be $0.1 and $0.2 for the months of June and July, respectively. In this scenario, the investor may choose to close the position by purchasing (or taking a long position in) the existing short spread for its spread value ($0.2-  $0.1 = $ 0.1). That leaves the investor with $2- $0.1= $ 1.9 before transaction costs. If, on the contrary, the underlying stock moved upside to $75 in May, with the market prices of the underlying options probably being $19 and $20 for the months of June and July, respectively. In this case, the investor could buy the spread for $20 – $19 = $1 and then close out the position at $ 2- $ 1= $ 1 point profit less transaction costs.