I'm no expert at calendars. I trade them but on a much smaller scale than I trade iron condors. On the surface, they're easy to set up and easy to adjust. They offer plenty of potential profit for the amount of money withheld to meet margin or buying-power requirements. They offer a nice volatility hedge to a portfolio that might be short vega due to a lot of butterflies and iron condors. However, scratch beneath the surface and you can reveal a nasty volatility-related illness waiting to swamp the hapless calendar trader.

For newbies unfamiliar with the strategy, the calendar is established by selling a call or put position in one month and then hedging by buying the same strike call or put in a further-out month. For example, a trader might establish a May/June or June/July calendar. The calendar is labeled a horizontal spread. It is a positive-vega spread, which means that it tends to perform better when volatilities are rising. Therefore, some prefer to put a calendar on when volatilities are low and reaching an important support level.

How does one determine such a thing? Although purists and experts will offer valid arguments against using volatility measures such as the VIX and RLX as measures of SPX and RUT volatility, they still serve as a rough-and-ready measurement for calendar traders. You want to know that these measures are in the lower portions of the graphs, not near highs for the last three-to-six months.

What about equities? Most brokerages offer some type of chart of the implied and historical volatilities of various underlyings.

IBM 3-Month Volatility Chart from BrokersXpress:

As of April 29, 2011, when this article was roughed out and the volatility chart snapped, IBM's historical and implied volatilities were each at or near three-month lows.

There's more to this deceptively simple trade, however. Because the trade is a horizontal spread, we're dealing with volatilities in two separate months. What happens if a sharp move is deemed temporary? Volatilities might pick up in the front-month option that you've sold while they stay steady in the back month, which would hurt the calendar trade over the short term. Eventually, as expiration nears, the extrinsic value is going to bleed out of those front-month options.

Getting a good price becomes important in the calendar trade, and that's what I've been experimenting with lately. Some traders who are nifty with Excel or other programs set up a spreadsheet that can calculate calendar prices and update them, and they'll watch those prices over a period of days or weeks before entering a calendar. They'll soon have an idea of what constitutes a good price for a calendar on that underlying at that period of time.

Some with back-testing platforms will back test through many months of trades, perhaps figuring out what calendars tend to cost at 30, 35, 40 or other days before expiration. That can accelerate the appreciation of what constitutes a good price. Even those with rudimentary trading platforms can model a calendar and update the price over several days, again seeing how the price changes.

If you have Think-or-swim, you can do more. You can set up a simulated calendar trade in the preferred vehicle. Then you can right-click on that spread and select "Market Depth." I apologize in advance to those of you who like to print the articles and don't like a dark background, but the light background doesn't show up as well for demonstration purposes. I avoid using these dark charts as much as possible, but I needed them for this article and wasn't able to determine how to change the background anyway.

Market Depth for an ATM May11/Jun11 Calendar:

In that Market Depth screen, you'll see "Composite." Right click on that, and you'll get a pull-down menu that includes TOS Charts. Choose that and choose one of the squares, and the spread's price will be charted. It's then possible to set up the chart as a daily or intraday chart. Volume is visible.

IBM ATM MAY11/JUN11 Calendar Price Chart:

I've drawn horizontal yellow lines that encompass most of the candle bodies produced Friday, April 29, 2011. Below, you can see the volume of those calendars traded. I wasn't one of the people trading these calendars, and I'm not recommending the trade as I am not familiar with calendars traded on this vehicle. Since I tend to trade the indices, especially during earning season, I don't even know if IBM is currently a good calendar candidate, but someone apparently liked trading them, and volume was high on that Friday. Those candle bodies stretch from about 1.33 to 1.43. In this case, that's roughly the same as the bid/ask spread for the trade, but that isn't always true. I've charted calendar prices that are on a sharp upward slope and waited for a retest of a rising trendline before putting in my order as a price on the trendline. That wouldn't be enough if I were trying to trade calendars in a high-volatility environment, however. A lowering of volatility would likely send prices breaking through that rising trendline. As of a week ago, when this article was being roughed out, that wasn't the case. Although volatilities could move lower and cause calendar prices to break through support, the chances of that happened for long were lowered.

This is another way of examining calendar prices over recent days. Will this chart or a proprietary Excel spreadsheet or watching prices on a simulated trade or on BrokersXpress' order page help me profit more consistently on my calendars? That remains to be seen, but knowing what constitutes a good price for a calendar can't hurt. Overpaying for a calendar puts me at a disadvantage right away.