Lesson Overview

Calendar Adjustments

Calendar spreads are low probability trades to begin with but that doesn't mean that we can't make adjustments that increase their likelihood of success should the stock move fast and one direction.

As with most of the strategies that we will adjust the mechanics will remain roughly the same, i.e. rolling one side of the trade to follow the market and collecting additional premium to reduce risk.

With calendar spreads in particular we will always look to adjust the front-month contract that we are short, moving it up or down based on the stock's movement. We rarely will touch the back-month contract we are long.

More Discussion

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  • Glenn

    So, I guess this only works for a credit on a Put calendar that goes up or a Call calendar that goes down. We can make similar adjustments for a debit if they go in the opposite direction. Is there a compelling reason not to do that? I know it would increase the risk (and use more buying power), but the risk is on the side away from the way the underlying is currently moving. And I guess it would cut your max profit a bit, as well. But, we’re not waiting for full profit anyway.
    What do you think? It there a viable strategy there or am I missing something?

    • Generally yes. These are low probability trades to begin with so there is little beyond this that I would do to adjust them and adding to the position is not a viable strategy in my opinion. We also have another tutorial on debit spreads in this section you can check out.

  • Jose

    Kirk, can the calendars spread apply to weekly options??

  • Steve

    I can’t seem to make this work. I always end up with a vertical spread as a whole new position and the calendar spread is still there as before. ???

    • If you have options in two different contract months it should be a vertical.

  • You could roll to a later date – not preferred but possible.

  • Modifying the existing position.

  • Wayne

    In this example the underlying moves to 210, but your adjustment only resets to 205. Is this representative of how much of an adjustment should be made? In other words, should the new strike be somewhere between where it originally was and where the underlying is currently? Why not all the way to 210 for a bigger credit?

    • Good question – it varies on time until expiration. The closer you are to expiration the more aggressive you want to adjust and visa versa. In this case we still wanted to leave a little room in case the stock came back down.

  • Wayne

    Yes, that what I suspected. Logically, time to expiration should determine the aggressiveness of the adjustment in most (if not all) strategy adjustments.
    Thanks.

  • Yep in that case it’s hard to adjust when it goes beyond your strikes. My view is that in that case you’ll have an opportunity to close it for a profit usually as the stock moves through your “profit window” so be sure to have a working, automatic closing order ready.

    • Nishchal Sharma

      Thanks for the reply kirk. Is it right to sell ATM put (near) for calender? or just move one strike lower to have a breathing space. I guess we can get a kick from volatility in a put calender since stock moving down increases volatility and calender benefits from it.

      • Yeah I would skew it a little in the direction you think the stock would go (in this case we would skew a couple strikes lower).

      • Nishchal Sharma

        Thanks for the quick reply kirk. Your videos has immensely improved my option trading. I trade with more confidance. God bless.

      • Great to hear – please share them online for us!

  • Very welcome – you could roll calendars as long as you do it insanely cheap or for a credit.

Show Video Transcript +

In today's video, I want to talk about how we make adjustments to a calendar spread that we are currently trading. Calendar spreads are low probability trades, to begin with, but that doesn't mean that we can’t make adjustments that increase their likelihood of success should the stock move fast in one direction.

Here's the thing. You have first to make a calendar spread trade in the right situation, so low implied volatility so that you get decent pricing in the spread and so that you have a good opportunity to make some money.

Even though they can be a little bit lower probability trades, not to say that they're not losing trades, but they don’t have the type of probability of success that says a strangle or a straddle does. But it doesn't mean that we can’t make adjustments to them.

For example: Let's say that you are trading a slightly out of the money put calendar spread and the stock then makes a huge move up very quickly.

The whole idea here is that you're trading the put calendar spread which means you’re a little bit directionally bearish, you want the stock to go down, but instead of the stock fading down or slightly moving down, it makes a really big move higher very quickly.

In this case, what we’ll do is we will look to possibly adjust the front month short strike that we’ve sold when it decays in value by more than 50% or 75%. What we'll look to do is roll that strike closer to where the stock is trading right now.

It’s a consistent theme here with a lot of the adjustments that we do at Option Alpha. In this case, let’s say that you sold a 203 February put strike for $255 (that’s your front month contract because it's closer to where we’re currently at) and you bought the back month contract or the 203 put strike for $435.

The net debit that you ended up paying for this strategy is 180, so your max risk is still capped at 180, but we want to be able to possibly reduce that risk or cut that risk down if the stock does continue to move higher.

What we ended up doing here is we’d roll that front month contract, that February put strike much closer to the stock’s new price for an increased credit.

Make sure that you analyze this trade first to ensure that you still have a decent probability of success, that your window of opportunity here with the calendar spread still looks pretty good as far as how many days are left until expiration.

You have to be a little bit judgy, have a little bit of common sense in here to see if it’s realistic. But the whole idea is that we’re taking this original calendar spread which is in red and we’re shifting it and tilting it higher which is the dotted calendar spread adjusted profit and loss diagram, just assuming that the stock rolls higher a little bit.

We want to take advantage of that by moving up that front month contract. What we’re actually going to do is we’re actually going to go to our broker platform here in Thinkorswim and what we’re doing now is just analyzing a trade that we setup.

This is in SPY which is currently trading at about 205 and we did the 203 February options that we’ve sold and we went ahead and bought the 203 March options that are going to be our back month.

These February options or the 203, that’s the front month, and the March options are the 203 in the back month. You can see that the net difference between those two is about $180. This is what the position would look like as we start off.

You can see the stock is trading right here at about 205 and we have this calendar just a little bit tilted towards the bearish side. We want it to go directionally bearish and what's going to happen is if the stock does make a huge move in this direction or goes higher, then we want to make an adjustment to this trade.

The stock is currently trading at about 205, so let’s say that all of a sudden we see the market really take a huge move up and now the stock is trading at about 210, so it makes about a $5 move higher.

At this point, it’s well outside of our breakeven points. We’re starting to lose about $50 on the trade. What we need to do is then roll up the put side closer to where the stock is currently trading. I’m going to go back to these simulated trades here.

If the market is currently trading about 205, we might roll it up closer to where the stock is trading right now. In this case, we’d be rolling just these February contracts closer to the market. We would not touch the current March contracts because those are the far out contracts.

We don’t want to mess with those. We want to touch the side that we’re short or these February 203s because these are losing value and becoming profitable, so now we want to bank that profit, roll up that side of the trade and take in more credit.

How you would logistically do that is you would sell a vertical credit spread for February. We just use a vertical credit spread, and we adjust the strikes to 205 and 203. The reason we do this is that the 205 is going to be our new short strike.

We’re going to sell one of those contracts and the 203; we’re going to close out and buy which is going to cancel out the one contract that we had for February that was already short. It closes out the 203, reestablishes the 205.

You might get some credit, maybe $.70, maybe $.50, something like that. You might get a smaller credit than your initial trade. But now you can see that that profit and loss diagram is starting to shift a little bit.

Now, it’s starting to be a little bit more shifted towards the topside of the trade instead of looking like it did before where it just was very even over 205, and you can see it was very neutral.

Now we’re shifting the diagram, and we’re reducing the risk on this side of the trade which is the side of the trade that the market is moving against or towards and technically taking a little bit more risk on this side of the trade.

But that's okay because if the market is currently trading up here at 210, it's got to work through a big profit window before it gets back down to being a loser. We’re okay taking a little bit more risk on this side of the trade, adjusting the trade and shifting this profit loss diagram just a little bit higher.

The key here with calendar spreads is that with this adjustment, it creates a new diagonal spread that is skewed higher in the direction of where the stock is going but also reduces the risk to the side of the spread.

That's exactly what we want to do, take advantage or realize that the stock is going higher, accept that and make an adjustment to protect our position and reduce our loss.

You can keep adjusting in the same fashion should the stock continue to rally higher and we suggest that you take a look at our CMG case study that we did because we had this happen with a CMG trade that we made, and we adjusted I believe three or four times.

We had rolled it up and whittled the loss down about 75% from what it was going to be without any adjustments, so a really good case study on making that adjustment. As always, if the stocks move in the other direction, you can take everything that we did in this video and apply it to the other side of the trade.

If the stock is moving down lower towards your position and you have a call calendar spread, you can roll down that call side as well and take advantage of the same type of mechanics in adjusting.

I hope you guys enjoy these videos. As always, if you have any questions or comments, please add them right below. Until next time, happy trading!

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