A long calendar spread with puts, also known as a time spread, is a position made up of selling a short-term put and buying a long-term put with the same strike price. The idea is that the shorter-term put, with more accelerated time decay losses value more quickly as expiration approaches and will hopefully be worth nothing or close to nothing at expiration, while the longer-term put retains most of its value. By selling the shorter-term put, this reduces the cost of the trade.
The trader wants the stock to trade right down to the strike price, but not under, at the shorter-term put at expiration. Once this option expires worthless, then a single long put is left, allowing for profits if the stock continues to trade lower.
This position has unlimited profit potential, at least until the stock reaches zero, but not until the shorter-term put expires worthless.
If the stock has a sharp move in either direction before the short-term put expires, then the time value of this spread becomes worthless, and the trader will lose his premium paid for the trade.
The long calendar spread with puts has two breakeven points; they both happen if the stock has a sharp move higher or lower before the short-term put expires. However, because the time value of this trade depends on the volatility level, it is impossible to know exactly where these points are.
If stock XYZ is trading $105 and we buy a 100-strike price long calendar put spread that consists of selling a March call for $3 and purchasing a July call for $4.50, then our next cost would be a $1.50 ($4.50-$3).
If the stock trades down to $101 at March expiration, the March puts would expire worthless, and the short March puts would get removed from our account. Now we are left with just the long July puts. If the stock traded down to $90 by July expiration, then we would profit $10 on the puts, but because we paid $1.50 for the position our profit would be $8.50. Consider this as if we only bought the July puts to begin with (not selling March) our profit would have only been $5.50.
If the stock traded up to $120 by March expiration, the short-terms puts would expire worthless, but the longer-term July puts would be so far out of the money, they would have almost no value left. Here the investor could sell out of the positions for pennies or hope for a miracle. However, if the stock fails to reach $100, the longer-term puts would also go to zero, and the investor would lose his $1.50 investment.
If the stock traded down to $70 by March expiration, both sets of puts would be so far in the money, they would essentially have the same value, made up of entirely intrinsic value. So, the $1.50 paid for the position would be gone.
It is recommended to execute a long calendar spread with puts if you expect a stock to trade lower, but that move will be in the future after the short-term puts have expired.