With markets sharply down this morning, we want to extend the profit range of our EEM July/Sept calendar put spread to the down side by rolling half of our position at 140 to a put calendar spread at 130, as follows:

-2 EEM Sept 140 put
+2 EEM July 140 put
for a net credit of $3.80;

+2 EEM Sept 130 put
-2 IBM July 130 put
for a net debit of $4.40.

Again, the two-contract trade size above represents half of our position. We now have a double-calendar with break-evens at $128.30 and $142.60. We’ve reduced our position delta from more than 60 to less than 25, and raised theta from about 12 to about 16.

Neither of the scenarios outlined in yesterday’s Update materialized today. While the Dow was down more than 150 points at its lowest, EEM held yesterday’s low and appears to be headed for a close above$134. On the other hand, implied volatility remains near yesterday’s close/high, failing to give us the break we would’ve liked in order to buy a second July calendar spread. Nevertheless, we’ve found a July/August calendar spread that looks like a reasonably good trade.

The Thesis

At our limit price of $1.15, the IYR July/August 61 put spread has break-evens near support in the $58–$59 range and down-trend resistance at $64. And because strikes are $1 apart, we’ll have lots of flexibility if we have to adjust.

The Trade

We’re opening the following Calendar Options position for July expiration:

+4 IYR August 61 put
-4 IYR July 61 put
for a net debit of $1.15.

Our break-even points are at $58.10 and $64.10. Our initial delta is essentially neutral.

Remember that we need at least 4 contracts per leg when we open a single-calendar trade, so we can split our position twice if necessary.

The first month of Calendar Options trading was characterized by the high day-to-day price volatility typical of market transitions. As the late-March to mid-May bear-market rally came to an end, we were buffeted in the buying climax and the sharp selling that followed—but we still came out with an average profit of 6.59%, handily beating the market. (If you’re wondering how we come up with our dollar return and percent return figures, see Calendar Options: How We Calculate Returns.)

Performance comparison

Market performance for the past month:

• S&P 500: −7.54%
• Dow Jones Industrials: −8.81%
• Russell 2000: −2.09%
• S&P Covered Call Fund: −5.62%
• Calendar Options: 6.59%
  Note: The time period measured is from expiration to expiration.

June Calendar Spreads

• EEM June/Sept 140/150 Double-Calendar: 16.72% return – No sooner had we opened this trade than EEM took off on a 5% rally over four days, forcing an adjustment. The following Monday brought a dramatic reversal, and three weeks later EEM was nearly 10% off its climax high, when we had to unwind the first adjustment. A relief rally brought the position back to our 15% minimum profit target Monday before expiration.
• RTH June/July 95/100 Double-Calendar: –4.23% return – We opened with RTH in the middle of what looked like a developing trading range. We were right about the trading range, but two adjustments were triggered, by a false breakdown and then a false breakout. With our position on the ropes, we made a third adjustment to up our odds of recovering our loss. On Monday before expiration, we were able to close nearly all of our position for a 1.41% loss; but to get the remainder filled we had to lower our limit price later in the day, for a 7.04% loss. The –4.23% return above is the average of our two fills.
• IBM June/July 125 Calendar Spread: 7.28% return – IBM had its share of volatile swings as well. A sharp two-day rally, culminating in a breakout, triggered a first adjustment, and after a reversal and two 2+ standard-deviation down days, we needed to reduce our risk by adjusting again. With the market looking shaky and our gamma risk growing, we closed the position four days before expiration for a modest profit.

June Reading

Anyone interested in following the Calendar Options strategy should be sure not to miss these key posts:

• Introducing Calendar Options
• Calendar Options: Five Things You Need to Know About Calendar Spreads
• Calendar Options: Puts or Calls?
• We Get Letters: Calendar Options Position Sizing
• Adjustments, Part I – Why We Adjust
• Adjustments, Part II – When We Adjust
• Calendar Options: How We Calculate Returns
• Adjustments, Part III – How We Adjust

We opened one July calendar spread, on EEM, last week. Even though EEM lost $4.63 on Friday—twice the one-day standard deviation—we’re already showing a small (1.15%) profit. We plan to enter another position this week if volatility stays near its Friday range, or drops significantly.

We published the following bonus trade for our members back on May 2:

Buy to open XLE June 70 put
Sell to open XLE June 72 put
Sell to open XLE June 90 call
Buy to open XLE June 92 call
for a net credit of $0.47 or better.

Anyone following this trade should have already exited - remember, we want to be out of any front month short options by Monday of expiration week at the latest.  Negative gamma risk during expiration week is ever a clear and present danger.  If you’re still in the trade, you would exit here by buying back the XLE June 90/92 call spread for a net debit of about $0.25.

Analysis: The original rationale for this trade was that the big rally in energy through March and April seemed to be stalling, so we wanted to get neutral and sell some premium.  We were right (for about 2 weeks), but then XLE spiked up in mid-May to a high of 91.42, which induced raw panic among a couple people who were following this trade.

Our answer then was the same as always: play defense first.  Figure out how much capital you’re prepared to lose on the trade in question, and then size your position accordingly.  That way, rather than running away every time an underlying shows a little spunk, you can sit tight and let the probabilities work themselves out.  If the trade hits your maximum loss point, so be it.  Sometimes those losses will occur, and sometimes, as in this case, the underlying will practically bounce off your short strike and revert to profitability (see chart).

If you waited to exit until today (and hurry up, better to get out ahead of the inventory report at 10:30), you’re still looking at a return of 14.37% on capital risked.

Despite having triggered two adjustments on our June/Sept 140/150 double-calendar, EEM was pretty good to us this month, yielding a 16.72% return on total capital risked. As we noted Monday morning, we would’ve liked to roll the short options out a month, but the EEM July/Sept 140/150 double-calendar is looking too bullish for our taste right now.

We could have rolled the short puts at 140 and monkeyed around with all the other adjustments that would be needed to set up a better July position—but it would’ve involved a lot of complicated trading, and we thought it was easier just to close the entire position and open a new one for July.

The Thesis

Average implied volatility for EEM options has been rising, but it’s still in the bottom 1/3 of its 12-month range. A 140/145 double-calendar would be close to neutral, but it would give us only about $6 to the downside before an adjustment would be called for; the 135/140 double-calendar has more downside room, but at the expense of range to the upside.

A single-calendar put spread at 140, on the other hand, could tolerate a drop of more than $10 in the share price, and its upper adjustment threshold is actually higher than it would be with the 140/145 double-calendar. And even though it’s a bearish-leaning position overall, our initial delta is actually quite small.

The Trade

We’re opening the following Calendar Options position for July expiration:

+4 EEM Sept 140 put
-4 EEM July 140 put
for a net debit of $4.35.

Our break-even points are at $131.80 and $149.80. The initial delta for the reference position is about -8, and theta is more than 13.

Remember that we need at least 4 contracts per leg when we open a single-calendar trade. This gives us enough contracts to split our position twice if adjustments make it necessary to do so. Also note that we may be able to close half of our position at our 15% to 20% profit target and go for a higher profit with the other half, in which case we’d need at least 8 contracts per leg (so the remaining position is still adjustable).

Nevertheless, we never want to risk more than we’re willing to lose in a worst-case scenario, and we strongly advise anyone who wants to follow Calendar Options trades not to risk their hard-earned savings unless and until they have a good understanding of the strategy. (”This is not a recommendation to buy or sell any investment, etc., etc. . . .”)