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| Basic Calendar Adjustment Questions Posted: 28 Feb 2012 06:36 AM PST When and how should I adjust my single calendar to a double? Trading calendars on lower volatility stocks can be a lucrative income trading business. Today we’ll discuss some basics of adjusting calendars using IBM as the underlying stock. Let’s start with some parameters for the trade. In this case we are going to do a relatively small trade, using no more than 4 calendar spreads total, which equates to a margin of a bit less than $1,500. So right away there is a question. Should we put on all 4 calendars initially? Or should we put on only half of our calendars, and “scale-in” to the trade? If we start with all 4, then when we adjust we would take off half of the existing spreads, and move them to a new strike to create a double calendar. At the start of the trade, the position looks like this:  Jay Bailey's Calendar Adjustments -- Figure One After nine days, IBM has moved up from $176 to about $189, and the position now looks like this:  Jay Bailey's Calendar Adjustments -- Figure Two Notice that, in addition to losses because of moving up $13 in nine days and increasing negative delta, this position is also suffering from a drop in implied volatility of nearly 20%. Combined, this results in losses of just over 7% for the trade. This means that we’ve suffered a 7% loss on all 4 contracts of our calendar. Now converting to a double calendar, we sell 2 of the 175 PUT calendars, and buy 2 of the 190 CALLs. This results in a new position delta about -10.84, about a third of the original position delta.  Jay Bailey's Calendar Adjustments -- Figure Three Now, this is a pretty typical calendar adjustment. However, what if we only put on 2 of our 4 calendars at the start, and added 2 more at the adjustment point? That adjustment strategy has this result:  Jay Bailey's Calendar Adjustments -- Figure Four Buying only 2 calendars at the beginning and adding 2 more when adjusting to the double results in a position down only $66, as opposed to being down $120 in our original adjustment strategy. The margin is also slightly smaller, at $1511 compared to $1573 for the same position, and our delta, theta and vega are very close to being the same. Clearly in this case, the second adjustment strategy is better. But is that always true? Under what scenario would the first adjustment strategy be superior? The answer is, if the stock didn’t move far enough to require an adjustment, and the position stayed within the “tent” of the initial calendar. If that were to occur, then buying all four calendars initially would have the advantage. We would have our full capital in the trade, and our full theta decay would be working for us the whole time, instead of just half. The other question is, if we use only half of our initial contracts at the beginning, what if the stock does stay within the initial calendar? Is there a point at which we should add the other half anyway, even if the calendar doesn’t need adjustment? When? So there are trade-offs to both approaches, and the question is more complicated that it might first seem. So, what is the right answer? Of course there is no “right” answer, only the right answer for your particular situation. It will depend on the vehicle you are trading to some extent. I’ve adopted the following rules-of-thumb, which may be useful for you. If you are trading your calendars on an index, such as RUT or SPX, I tend to put all of my calendars on at once, and move part of them to create the double. This is because I find that indices tend to be a bit more stable, with less gaps and possibly a lesser tendency to suffer as much volatility crush as a stock with the same market movement. Since the underlying tends to be a bit more stable, I’m “all-in” at the beginning counting on the tendency of the index to stay within the bounds of the original calendar a bit more often than a stock would, and with less volatility change. On a stock, I do the opposite, for the opposite reasons. I’ll put on half of the contracts and add the other half when I adjust, and the IBM example above shows how this can be an advantage.
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