Lesson Overview

Complete Guide to Adjusting Credit Spreads, Iron Condors & Calendars

In this video, I'll walk you through the complete strategy and techniques we use for adjusting credit spreads, iron condors, and calendar spreads including more than four different detailed examples of real trades we adjusted and turned around.

Show Video Transcript +

In this video, we're going to go through some "Defined Risk" Option Trade Adjustments.

Now, just as we did in the last video on Straddles & Strangles, right here on track #3, I'm going to cover the exact techniques and strategy we use to adjust trades with "defined" or "capped" risk profiles.

So these would be things like Credit Spreads, Iron Condors & Calendar Spreads. Now it's important to consider that these options strategies already have limited risk, right? You are already buying or selling or have defined risk in these trades.

So even though the same overall techniques are the same and apply the same way as they do with the last video on Straddles & Strangles, you're going to be somewhat limited in the types of adjustments or the aggressiveness of the adjustments that you can make.

What it's mainly going to do is limit the ability to possibly turn all these trades around and make them winners. You're going to be more focused on these types of trades on reducing risk. Not necessarily on potentially making any money off of these trades.

But, again in capping the amount of risk that you have in the position or reducing the amount of risk that you have in the position.

Now as always the key points to remember about making adjustments are:
1)Don't move the losing side.
2)Always take in a net credit. We never want to be adjusting trades and paying money to do so.
3)Recenter the trade whenever possible. What that means is we want to acknowledge the face that the stock has made a higher move or lower move. By making an adjustment, we try to recenter the stock and have the stock in the middle of our break-even points, or new break-even points whenever possible.
4) That kind of goes along with #2, we want to widen the break even points which are going to naturally happen as we take in a higher and higher credit.

Before we get into some case studies, let's go through a couple of examples here on how we can make these adjustments. Just the overall strategy and high picture in a kind of 10 000 foot view here.

When you are doing or dealing with credit spreads, for example, after selling a call credit spread above the market. So, you'd sell ... If the stock was trading at 50 or something like that, the stock would be here and stocks trading at 50; you would sell for example ...

Let's say that 55 calls and buy the 60 calls or something like that. You'd be selling options above where the stock is trading. The question becomes, how do you adjust or hedge this type of trade?

It's already a risk defined trade. You've already sold one option, bought one option, you already have defined risk here, and you should be naturally entering this position with a small position size.

For simplicity sake, let's say that you sold a $1 wide spread for 20 cents at a 15% probability of being in the money. That's about a 15 delta on the short strike. What we would do is look to adjust this trade when the short strike reaches a 30 delta.

So again, if the stock starts here at $50, once our short strike on the call side reaches a 30 delta, we'd maybe look to adjust the trade. Again that will factor in different time, and volatility indicators into the fact that stack may be rallying up a couple of dollars or implied volatility may be rising.

Whatever the case is ... Just to use a guidepost, we might look to adjust this trade once the stock reaches a 30 delta. Now, we've got video tutorials on adjustment triggers, so go ahead and look at that. We are not going to cover that here in this video.

What you would end up doing if the stock did rally towards your call spread is you would sell a corresponding put spread on the other side of the market for additional credit. What you do is match up the number ...

The width of the strikes which is $1 in this case and the number of contracts and turn this thing into an iron condor with no additional risk in the trade.

So again, what you are going to do is, you are going to take that original call spread side. You are not going to touch that call spread side, but what you are going to do is ... You are going to add a put credit spread down below the market to turn this into an iron condor.

If you sold a $1 wide call spread and you did three of them, you would sell another $1 wide put spread, and you would do three of them, so you make everything the same. If you do that you take in no additional risk because the market can't be on both sides at expiration.

If you don't increase the risk in the trade meaning, keep the strike width the same, keep the number of contracts the same ...

All you are going to do by selling this additional put credit spread is reduce the risk in the trade and again another little thing that is really cool about this is that when you do this and create this new iron condor, it's going to help widen your break-even points by the amount of the credit that you receive and again it will recenter the trade over where the stock is.

So if the stock is now trading at 55 here, now you can see our new iron condor which is in the dotted line is kind of right centered around where the stock is trading. Initially the stock might have been trading down here around 50 as we talked about earlier.

Now the stock rallies higher. This new iron condor which is a little bit taller, a little bit more narrow, is now a little bit more centered around where the stock is trading, okay. After selling a put credit spread, just to use the other side of the trade so we can go through all these examples.

After selling a put credit spread below the market, if the stock were to fall against your put credit spread side ... again assuming that we sold the same type of $1 wide spread ... We would again look to adjust it if the put side reached a 30 delta.

In this case instead of selling the corresponding put spread, since we already have a put spread, we would go ahead and sell the corresponding call spread side to the trade.

Now we would leave the put spread side completely alone. We're not going to touch that side and we are going to go back in and resell a brand new credit call spread, and that's going to create this iron condor.

Again, as long as we keep the number of contracts the same, the width of the strikes the same, we're doing this for no additional risk. Again, this new iron condor creates wider break even points, helps reduce risk because we increase the credit in our trade and gives us a better opportunity to make money on this trade.

It's not always going to work out that way. We are not always going to have an opportunity to close a trade for a profit, but it's going to reduce risk which is your first and #1 goal always of making adjustments.

Before we get into more examples, let's go through two more case studies here on how you can make adjustments with risk defined strategies. Let's assume now that you start with an iron condor.

In the previous examples you started with a credit spread on either side - put credit spread or call credit spread and you turned it into an iron condor. What if you have an iron condor and what if you start off with an initial iron condor?

Let's say the stock is trading at 50 and you start off with a nice even and balanced condor. Well, a challenge is you don't know which side to adjust or which side to move, but you always want to move the side that's unchallenged closer to the new stock price and take in credit. The same rules apply that we talked about.

If for example, the stock moves from 50 and moves up toward say 55 then we do not touch this side of the trade. We don't touch our call spread side. Instead, we move our put spread side closer.

If the stock goes from 50, right in the middle, and starts moving down to say 45 in this case, then we don't touch the put spread side, we move the call side closer. That's exactly what we are going to do here. The same rules and techniques apply, it's just in a little bit different fashion.

Once you roll one of the side closer to where the stock is. In this example, we assumed that the stock moved higher toward our call spread strike. Let's assume the stock moves up to that $55 price point.

What you are going to do is you are going to close out of your current put spread and reenter a new put spread closer. Okay? It's the same technique. It's the same thing that we did with short straddle and short strangles.

We close out of the profitable one, and we move and reestablish a new position a little bit closer to where the market is trading. Again, notice how it gives us a little bit more balance over this new iron condor.

It creates this taller, more narrow iron condor that both reduces risk and widens our break even points to the side that the market is challenging. Notice our break even point got a little wider on this side by the credit ...

Gives us a little bit more room for the stock to move higher and still potentially make some money on this trade. Most important, being that it reduces risk first.

The last one we want to go over before we get into some case studies here is calendar spreads. Calendar spreads are low probability trades, to begin with, but that doesn't mean that we can't make adjustments to increase the likelihood of success should the stock move fast in one direction.

For example, let's assume that we bought a slightly out of the money put calendar spread and the stock makes a huge quick move higher. Now, remember when we're doing a put calendar spread, we're trading those put options in the direction of where we want the stock to go.

If we do a put calendar spread, we assume the stock moves down. If the stock moves up, that's a bad thing. If we do a call calendar spread, we're assuming the stock is going to move higher so if the stock moves down, that's a bad thing.

We'll look to possibly adjust the front month's strike we sold when it decays in value by more than 50 or 75 percent. Now that's not a hard fast rule. It's just something to look out for.

You can look for that adjustment depending on if the stock front-month strike price that you sold decays in value by more than 50% or you've gotten at least a little bit of credit in there to potentially make a trade.

So let's assume in this example ... Just use a couple of numbers and then we'll get into a real case study here with CMG. Let's assume that we sold the 203 February put and then bought the 203 March put.

Again, this is going to be our front month, this February contract. This is our back month which is March. We sold this contract for 255. The March contract is at 435, so the net debit or the price that we paid for this calendar is 180.

In this case, let's assume that the stock is trading right here at about 205. If we want the stock to move a little bit lower, the peak of our calendar is going to be right here at about 203. We position ourselves to have this calendar slightly out of the money in the direction that we think the stock is going to go.

Stock is at 205 now, and so if we wanted it to go lower, it would go lower to 203. That would be the ideal situation. Let's assume instead that the stock rallies higher. So, it goes much higher than 205.

Now what we want to do is we want to take our 203 put option which was right here, in the front month which is February and we want to move that strike price closer to where the new stock is trading for an increased credit.

We might roll that put strike closer to, let's say, 205. The stock may be all the way up here at 206 or 207, somewhere around there, but we are going to roll that put strike ... Just the short put strike in the front month higher to something closer to where the stock is.

Maybe 205, 206, somewhere around there. Make sure that you analyze this trade first as always to ensure that you still have a decent probability of success because calendar has different pay offs.

There is no one way to do a calendar spread. There is a lot of volatility factored in here, but you can see what this new payoff diagram looks like once we roll that trade higher. We are reducing risk on this side of the trade where the market is moving against us.

This is when the trade moves completely against us. This creates a new diagonal spread which is skewed in the direction where the stock is going, but it reduces risk to that side of the spread.

You can keep adjusting in the same fashion should the stock continue to rally higher and we are going to go through our CMG case study right now for this call calendar spread to show you what happened when we traded CMG.

Back on October 21, we assumed that after earnings, CMG would continue to move in the direction that it had opened post-earnings. They had a bad earnings announcement, moved lower. We thought that the stock would continue to move lower, so we bought a ...

Or got into a 580 put calendar spread. We sold the November contracts. These are front month contracts, and we bought the 580 December puts, and we did a put calendar spread again tilting ourselves a little bit below the market and paid a whopping debit of $470.

This was our max risk in this trade at front month expiration ... Is $470. So that's how much we were willing to put up at risk. Now when you look at a chart here of CMG, we got into this trade right here.

This was the day that we got into it. Right after the announced earnings, the stock gapped lower. We tried to play the move lower down to around 480. This was our zone that we wanted the stock to go into. Again, that's a reasonable expectation given that the stock had fallen from about 700 down to around 610.

So it's not unreasonable to assume that that would happen, but as sometimes will always happen, the stock went completely the opposite direction. That ended up being the low for the next month and a half for this stock, and it never turns around ...

Never gave us an opportunity to hit our target zone. This is where we make money on this put calendar spread is right around 580. The stock went completely against us and moved up higher.

If we look at our actual account statement and position statement as we do with all these adjustment videos, you can see we got into this calendar spread on 10/21, we opened up the December contracts and went along the 580s and we sold to open the November contracts at 580 as well for 470 debits in this trade.

What ended up happening is that on November 6th, as the stock rallied higher against or away from our put spread strikes, we went ahead and bought back our 580 puts and rolled those up and sold the 610 puts. This is again exactly what we talked about in our adjustment techniques ...

Is that we are moving the side of the trade, the market is moving away from. In this case, it's moving away from our put spread strikes, so we are going to roll up our puts in the front month. We bought back our 580s; we sold our 610s ... We did this for a net credit of 159.

What that does, is that reduces the cost of this trade by $1.59. Remember the original cost of this trade was $4.70 so by reducing the cost of this trade by $1.59, we are left with a total cost or total risk now of $311.

Should the stock obviously continue to move higher, we only risk $311. Again this is on November 6th. So you can see here, November 6th, that's the date we went ahead and closed out of our 580 puts, and we resold the 610 puts for $1.59 credit.

Now, as the stock was rallying higher this is when we did it. This was on November 6th ... Was right about here so as the stock obviously started to move against us, we rolled our 580 puts from here, all the way up to 610.

We still gave ourselves some room for the stock to move because there's still time between now and expiration, but we did start to move up our put spread side. We did not adjust anything else. We just move the side of the trade that the market was moving away from.

On November 12th, we again rolled up our puts from 610 to 640 so as the stock continued to rally higher, we closed out of our 610 puts that we originally sold. We resold now the new 640 puts which are higher. We took in a net credit of $1.05.

That reduced the total cost of this trade down to $2.06. In this case, now our total risk should continue to move higher was 206. Here is the trade in real time. This is our real account statement. This is November 12th. We closed out of our 610 puts.

We reopened our 640 puts. We took in a $1.05 credit to do so and again; this is just giving ourselves more time as we continue to see the stock rally higher and higher and higher. We continue to roll up these puts from 610. Now we got a little bit more aggressive as we got closer to expiration and rolled them up to the 640 strike.

We just keep taking in the credit. Keep reducing risk on this trade the entire time. On November 21st, we were able to close out the entire trade for a net credit. We were still able to salvage some value out of this calendar spread and closed it for a net credit of $65.

That gave us a net loss at the end of the day, even after adjusting this trade, of $1.41. The key here being that not all trades can go completely around and become losers to winners and I wanted to show this in this case study in this video as some examples of that.

I think it's important that you realize, you still might have losing trades after making adjustments, but this is compared to the original cost to get into this trade at $470, so the question becomes, which would you rather have - a $470 loser or learn to make some smart adjustments that reduce your risk by more than half to ... $141.

In every situation everyone would say, I'd rather lose $141 on a trade that goes completely against [inaudible 00:17:17] that we can't control. Remember Chipotle went 100% against us. We got the direction 100% wrong, but that doesn't mean that we can just sit on our hand and just take whatever the market gave us.

We were diligent in making adjustments that helped reduce risk in this trade from 470 down to 141. The next case study I want to go over is a call credit spread in Amazon. Amazon is a stock that we like to trade often and back on August 24th; we had sold the 530/535 October call credit spread in Amazon.

In this case, we took in a net credit initially of $95. Since it's a $5 wide spread, the max risk in this trade since it's a risk defined position was $405. On the outset of making this trade, if Amazon went completely against us, before we made any adjustments, the most amount of money we could lose if we didn't do anything was $405.

Here is a chart of Amazon and back on 8/24 which is right here. That's when we got our call credit spread in Amazon. Again, what we had assumed is that ... Amazon made a big move after earnings but had fallen off of that big move.

We thought it's okay to sell a call credit spread at 530. That was one of our strike prices right here. 530, that's our line in the sand assuming that Amazon doesn't get back up here because it had fallen so hard off of that price point. Naturally, sometimes it happens where the stock completely turns around and goes 100% against you.

We ended up picking, out of bad luck, the bottom of Amazon after earnings and the stock kind of turned all the way around. After Amazon had turned around just a little bit and started moving higher ... On October 8th, what we ended up doing is selling the 525/520 put credit spread to turn this thing into an iron condor.

We sold that 520 put credit spread for $1.75 credit. So, we take in this $1.75 credit that's in addition to our $95 credit that we had on the original call credit spread, and now our total credit is $270. Now, it's still a $5 wide spread.

We didn't increase the spread width. We didn't increase the number of contracts. We didn't do any of that. Now our max risk in this trade is only $230 or a 43% reduction in risk. Notice, the focus of doing this is not to make more money.

Yes, we could have made more money on this trade with a total net credit of $2.70, but the focus in doing this was to the reduction in risk in Amazon. The fact that we reduced our risk from $400 to $230 if the stock continued to move higher.

Here's our trade inside of our platform. On October 8th, we went ahead an opened up a brand new put credit spread position below the market from where Amazon was trading. In fact, very close to our short strike on our call side.

Notice that was the same number of contracts, the same $5 wide spread that we originally had, and now we have this big credit that we can work with that helps offset some of the risks.

On 10/8 which was right about here, as the stock continue to rally higher, we did this trade so that we could reduce risk. At the end of the day, Amazon did continue to move obviously much higher than our ...

Than we anticipated, but even though it continued to move higher we were able to, on October 15th close out just the call spread side because that was the only side that was tested for a net debit of $468.

At the end of the day, we did end up losing on Amazon. There is no doubt about it. We're not hiding that. I want to show you that so that you realize that sometimes you are going to make adjustments and you are still going to lose, but the key here is that our net loss after adjustments was $198 versus the $405 that we could have lost we done nothing at all.

So think about it. If we had done nothing at all with Amazon, with our call credit spread side at 530 which is lying in the sand right here about 530/535. Amazon closed up at 580. Could you do anything about that?

The only thing you could do is think to sell the corresponding put credit spread, create an iron condor, and hope that Amazon comes back into this range. You couldn't roll the contracts to next month.

You couldn't do anything like that, at that period, but by making an adjustment like this, you were able to cut your loss dramatically in this trade by more than half. That's really what we're trying to impress upon you here tonight.

Another trade case study that we want to go through, the last one here, is a RUT iron condor. We're trying to get a good mix of everything in here so you guys can see exactly what we're doing.

The original RUT iron condor that we entered was back on May 15th, and we had sold a very wide 1140/1145 call credit spread, and 1000/995 put credit spread. That's about 140 point range on the RUT which is Russel ETF Index. It's still a $5 wide spread on each side.

Our net credit that we took in for making this an original iron condor trade was $1.40. We were pretty neutral in the market. We didn't assume that the Russell was going to go dramatically higher, dramatically lower.

We want to do a very neutral, very consistent iron condor trade. Took in a $140 credit because of a $5 wide spread that means our max risk was only $360 on the initial trade entry should we do nothing at all.

Inside of our think or swim platform, this is our original trade, back on 5/15. We had sold to open the original iron condor, the 1140/1145 call spread, and sold the 1000/995 put spread for a $1.40 credit.

Obviously, the stock continues to move higher after that point. Our initial entry was right about here. The stock continued to move higher against our call spread side immediately after we entered this trade. You can see that the stock breached our call spread side which was 1140 here, pretty quickly in the expiration month.

So, didn't give us much time to do anything, made a large move against our call spread side. We did not move our call spread side. As you'll see here as we go through these trade examples. All we did is we moved up our put spread side a little bit closer.

On May 23rd, as the stock ... Or the ETF was rallying; we rolled up our puts to the 1080/1075 strikes. What we did is closed out of our 1000/995 put spread. Closed out of that one and rolled up to the 1080/1075.

The net credit between buying back the original puts and selling the new put spread was 75 cents. That was additional credit that we took in. So, we add this to our original $1.40 credit, and now we have a total credit working of about $2.15, and we've reduced our max risk from $3.60 down to $2.85 for each one that we did for RUT.

Again here on this trade tab, what you are going to notice is that we went ahead and bought back to close the original 1000/995 put credit spread and then we resold to open the 1080/1075 put credit spread. That's how we get that difference that we talked about in the slides ...

Is the difference between these two orders. So all we're doing here is just rolling up our put credit spread side as the market moves against us. Our original put strikes were down here around 1000. Our new put strikes ... Again, we rolled up to the 1080 level.

All we did is just move up our put spread side, did not adjust our call spread side, closer to where the stock was trading as the stock was rallying higher. Inside of our think or swim platform, you can see we did this in two different orders.

First, we bought back our credit put spread that we had down below the market at 1000/995. Then we resold the 1080/1075 put credit spread for a $90 credit, bought back the original one for ... $15 ... debit, so that's how we get our net credit that we received on this adjustment and roll.

As the stock continued to roll higher, on May 29th, we again rolled up our put spread side closer to where the stock was trading. This time we rolled up our puts to the ... 1110/1105 put credit spread level, again for a net credit of $55.

This gets added to our original credit and all the credits that we've received, and now we have a total credit working of about $270, the new max risk of about $230 on this trade if everything goes perfectly according to plan at expiration.

What you can see in here is we did this in two separate orders. We first rolled up and opened ... Just a matter of filling so it wasn't that we did this on purpose, just FYI. We just got this one filled first a little bit earlier in the morning.

We opened up our new 1110/1105 put credit spread for $110 credit, and we bought back our existing 1080 and 1075 put credit spread which is the one that we had originally entered here. We bought that back for $55 debit after selling it for $90.

Now we've continued to roll up our short strikes closer and closer and closer to where the market is trading. Originally at 1000, then to 1080, and now to 1110. We just continue to roll these puts up closer and closer as the stock continues to rally further and further.

Again, notice that we are not adjusting our call spread side, at any point during this trade. Later on, on June 5th, we again rolled for the third time our puts up to the 1130/1125 level for another $50 credit. Notice we are still keeping the same mechanics here.

Nothing changes in how we go about this. It's the same mechanics the entire time. We keep rolling up the put spread side, not touching the call spread side and went ahead and collected an additional $50 credit.

Our total credit is now $320; our new max risk has been reduced to 180 on the trade. Again, we rolled up for the third time, closed out our 1110/1105s and entered the 1130/1125s. We did these in two separate orders, just to make it get filled a little bit sooner.

On June 9th, a couple of days later, we sold an additional 1150/1145. Took in another credit of $85. You're seeing how we're going through this process so I won't go to slow through here and kind of speed up a little bit.

It brings our total credit to 405, the max risk at $95 in this case. All we are just doing is continuing to take in credit. Eventually, between June 13th and June 17th, we closed out the entire position. We tried to leg out of it in a little bit of fashion.

At the end of the day, we ended up paying a net debit to get out of everything that we had entered into now of 559. That brought our net loss down to just $154 compared to the original $360 that we had on this trade or a 57% reduction in the loss from the initial onset of the trade.

So again, between June 13th and the 17th which is here ... So these are all the closing trades that we had. You can see we add up all these trades and how much it costs us to get out of each side of the different trades and it gives us our potential total P&L that we had and just discussed.

At the end of the day, and that's what I want to talk about. At the end of the June expiration cycle which is here, the market went completely against us, right? At the end of the day, went totally 100% against us.

We never adjusted the call spread side that started at 1140 until we closed it at the end of the expiration cycle. So notice that the last time that we adjusted or did anything with the calls ... Notice these are all puts ... puts, puts, puts ...

Everything puts in here except for the original call spread is the only time that we close that out is at the end. We never adjusted it, we never rolled it, and all we did is deal with the put side because that's the side of the trade that the market was moving away from.

So as the stock or as the index continued to rally higher, we just kept rolling that put spread higher and higher and higher. It ended up giving us a total loss at the end of the day, still of $154 which still was a loss. We still lost real money of $154, but that's much better than losing $360.

Yes, it took a little bit of finesse. Yes, it took a little bit of work. Yes, we had to be diligent in rolling these contracts, but at the end of the day, this technique that we have shown here and multiple different examples not only through this video but also the video previously here in track #3 continues to work and reduce risk and increase our overall chance of success in trading.

Making this work required the following:
1)Never move the losing side.
2)Always took in credit.
3)You have to focus on risk reduction first. That's the name of the game here is focusing on risk reduction with these trades. You can't help it if the market moves completely against you, but what you can do is cut the loss by a half or more.
4)Extend the trading timeline whenever possible. Roll these trades out if you can continue to take in credit so that you can extend the timeline and possibly see things turn around.

Again, your #1 goal with risk defined trade adjustments like credit spreads, iron condors, calendars, things like that is risk reduction. If you do nothing at all and enter the trade correctly, in the beginning, you'll still win long term. Even if you take all of the big losers.

You still should win long term. If you can consistently cut the big losers in half or more by making these types of adjustments, you'll just be that much further ahead of everyone else, okay? You'll be that much further ahead of all the other traders out there who don't know how to make adjustments. That's the kind of point that we want to stick with here ...

Is that with risk defined adjustments, you can be a little bit slower with these credit spreads and calendars and iron condors because if you are entering the trades correctly from the beginning, everything else should fall into place, but adding this adjustment technique or these adjustment techniques to your trading is just going to get you there a little bit faster.

Well, I hope that you guys enjoyed this video, thought it was helpful, and shown you the strategy behind making adjustments to these types of options trades. As always if you have any comments or feedback, I'd love to hear them in the comment section below.

Let me know if this video helped. If you loved it, please consider sharing this online, helping spread the word about what we're trying to do hear at option alpha. I would always be extremely grateful to get your referrals to your friends and family and just basically help us all make some smarter decisions with our options trading.

As always, hope you guys enjoy these videos and until next time, Happy Trading!

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