We talk a lot about why adjusting iron condors is rarely, if ever, a good idea, and adjustment decidedly is not a part of the Condor Options strategy. So you’re probably wondering, why all these Calendar Options posts about adjustments? The answer is simple—calendar spreads are not like iron condors.

A quick review: As we explained in Part I of this series, our decision to adjust calendar spreads is based on the same criteria as our decision not to adjust iron condors—probability. When we open an iron condor, we typically have nearly a 70% chance of expiring out of the money. And as long as we’re out of the money, we can keep most of our initial credit when we close the trade. Our winning trades have an average return of 23%, and a few have returned more than 30%.

A typical calendar spread, on the other hand, has only a 30% to 50% probability of being profitable when the short option expires. If we’re lucky enough to be near the money when expiration week rolls around, we could have a 50% or 60% return; but if the stock is as little as half a standard deviation away from our strike, every dollar it continues to move against us can slice 10 percentage points off that return. If we expect to get high monthly returns from calendar spreads, month after month, we have to do something to tip the odds in our favor. One thing we can do is open a trade as a double-calendar, but even a double-calendar has only a 50% to 60% probability of profit if left as-is.

That’s where adjustments come in. Calendar spreads provide ways to adjust our trades that extend our range of profitability if the underlying moves too far in one direction or the other. Read the rest of this entry »

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 July cycle so far has largely been a waiting game for our Calendar Options strategy. We wanted to wait until we’d closed out at least some of our June positions before opening our first July calendar spread. Then came a nasty expiration day, followed by the period of uncertainty heading into the Fed’s two-day FOMC meeting.

Today we again find ourselves sitting on our hands. We’d planned to open a second July calendar spread this morning, after the dust had settled post-Fed, but we got a dust storm instead. Sometimes the best way to trade is not to trade.

Nevertheless, it would be nice to balance the 48 delta of our EEM July/Sept 140 put position with another trade that has zero or negative delta, so if things settle down tomorrow we’ll be looking to open a bearish-to-neutral July/August calendar spread. But if the sell-off continues, we’ll have to focus on managing our risk by adjusting our EEM position ahead of the weekend.

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.