You create an out the money (OTM) put calendar spread setup by combining these two options:
- Selling (writing, going short) a near-dated put out the money (where the strike price is below the current stock price) with a short expiration typically less than 30 days) and,
- purchasing (holding, long) a later-expiring put at the same strike price in step 1 above. This position creates a net debit that you pay at trade entry.
When establishing an out the money (OTM) put calendar spread, the legs of the spread are created by zeroing in on a stock you believe is bearish.
The spread allows us to play the appreciation of the stock with a significantly reduced capital outlay. The position will benefit as time moves on so long as the underlying shares price moves closer to the strike price you selected.
Despite the fact that this position is a directional trade, It is a calendar or time spread all the same. This is because the strike prices of the short put (sold in the near term) and the long put (purchased at a later expiration) must be the same. The sale of the short-term put will partially offset the cost of the longer-term put.