Intro to Calendar Spread Trading

Updated: Nov 7, 2019



A calendar spread, also known as horizontal spread, is a market-neutral trading strategy which includes buying and selling the same underlying asset at the market price, but with a different expiration date. The idea behind this strategy is that investors can profit from the potential increase in volatility and passage of time.


Structure

The most traditional version of a calendar spread strategy is established by taking a long position with a long-term expiration date, compared to the short position with a near-term expiration date.


Of course, one can also go the other way around - establish a short position on a long-term contract and a long position on a contract with a near-term expiration date. With the time decay, the near-term contracts are losing value at a faster pace than the long-term contracts. Hence, investors are selling near-term and buying long-term.


Statistical Arbitrage

Similar to the calendar spread trading strategy, statistical arbitrage (“stat arb”) is another market-neutral strategy based on simultaneous buying and selling of two or more correlated assets. Developed by Morgan Stanley in the 1980s, the most popular version of this strategy is the so-called “pairs trading”. While the focus of the calendar spread trading is the duration of contracts, the stat arb focuses on the correlation between two or more assets.


The pairs trading strategy is designed in such a way that investors open a long and a short position in two different assets with a positive correlation. The apparent aim is to profit from the correlated asset’s mispricings as the net profit represents the total gained from the two or more positions.


As the name says, statistical arbitrage uses technical and statistical analysis to identify the best financial instruments for this strategy. In a similar manner to traditional stock market, where analysts search for companies in the same sector with similar market movements, cryptocurrency traders analyze the cryptocurrency market to identify two or more digital assets with a high correlation.


By buying and selling of two or more digital assets with positive correlation, investors hope that the value of the under-performing digital asset increases while the outperforming asset’s price deflates.


Risks

A major risk concerning the calendar spread trading relates to sharp movements in the price action in either direction that can have negative effects on short-term contracts. On the other hand, the fact that statistical arbitrage is based on historical correlation doesn’t mean that future trends will be replicated. For this reason, analysts target only pairs with a very strong positive correlation, which is extremely difficult to identify, especially in a relatively young and new market that one of cryptocurrencies is.


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