Hello everyone! It’s spring break in my end of the woods and I’ve found myself with some time to research yet another strategy. I’m confident you options traders out there are going to like this but let me know in the comments what pitfalls you’re seeing.
We received some unwelcome news today when we learned inflation is ticking upward again. Even still, the market soared! That said, if you read my recent post, “2 Stocks Marching Lower in 2024”, you may have noticed I thought this was a possibility. But if it’s me, I’m not chomping at the bit to buy in just yet. I still think March may yet make fools of us all.
Regardless, let’s move on to why I’m here. The 3-way Calendar Spread. In today’s post I’ll discuss the strategy, the ideal market condition, the “not-so-ideal” condition, and close with my preferred adjustments. So, let’s get into it!
Last thing, I promise. For those not familiar with the Calendar Spread Options strategy. It may be of interest for you to check out this post from WallStreetMojo.com – Calendar Spread. They do a thorough job of explaining the base strategy before you move on here.
3-way Calendar Spread Options Strategy Advantages
First, I like this strategy for a few reasons (I’ll explain each below);
- Position theta is attractive
- Delta can become very positive
- We have more options
I like seeing theta on my team, if you will. While it certainly isn’t a guarantee of success, it does prove helpful that theta get’s higher as the position sours. Next, if the position moves negative delta can become increasingly more positive. This is beneficial because with any upside move, even a small move, the position can recover quickly. Finally, by trading 3 calendar spreads at a time we exponentially multiply the options we have to overcome a bad trade. We’ll discuss my preferred adjustments later.
For now, let’s focus on building the strategy and we’ll circle back to why this strategy can work.
3-way Calendar Spread Options Strategy & Criteria
To open, the 3-way calendar spread options strategy is relatively simple. It’s just a calendar spread, 3 times. Wait, hear me out. It’s 3 different calendar spreads, spread across the options chain so that most any price move can be helpful. Let me explain further with an example.
Feel free to click the image above to have a closer look at the build out. Take notice of the positional theta and delta figures. This is the ideal setup for the strategy with theta higher than delta. Essentially all I’ve done is shotgun a calendar spread, ITM, ATM, and OTM. By doing so, any immediate move in the underlying can help the overall position. In this case, SPY.
As for my entry criteria, and this is in no way an exact formula, I choose to open my first calendar spread with the short at ~30 DTE and the long at ~60 DTE. In this case, the first calendar short was at 32 DTE with the long at 60 DTE. From there, I will move both the short and the long out to the next available expiration. I’m told a picture is worth a thousand words. Maybe the image below will help to clarify what I’m saying.
Lastly, as is the case with all Calendar Spreads, it’s helpful if the near month implied volatility is higher than the back month. Setting the trade up with the near month having having a lower implied volatility isn’t ideal. That said, we are opening 3 spreads so remember to consider the average of all front month contracts vs the average of their long counterparts.
As you’ll notice, the second Calendar spread has the short at 34 DTE and the long at 78 DTE. Lastly, the final spread is at 36 DTE and 106 DTE. By setting the position up this way, there isn’t a scenario where some of those contracts won’t become valuable, immediately. This is what we want so that if the underlying decides to take a dive we can adjust our way out of a loss. Settle though, we’ll get to that.
Ideal Market Movement
For the position to be an outright, no questions asked success we want the market to go nowhere. In fact, we would be happy if the market just stayed sideways every single day. By doing so the position wouldn’t require adjusting and we could easily close the trade just a few days later for an incredible percentage profit.
However, I caution you not to do to much “analysis” on the analyze tab in ThinkorSwim. I would NOT suggest we shoot for the stars and try to come away with anything close to a max profit. In the next section I’ll explain what I aim to achieve with the 3-way calendar spread options strategy.
Position Target
Ideally, I’m aiming to return 10% of the net cost. From the example images above my total cost was $892 for all 3 spreads. In that case, my target return would be $89 dollars. Not incredible, I know, but you’ll see momentarily that if the underlying stays relatively quiet that can be achieved in very little time.
Should the underlying make an extreme move immediately, in either direction, an adjustment will be required. Let’s now take a look at saving this position when things turn ugly.
Adjustments
As every option trader knows, the probability is high that right after you open this trade the market is going to get crazy. Fast! Having a secure grasp of the options at your disposal will certainly be beneficial to actually securing repeatable profits. Now, ideally, as mentioned above, we want the market to stay in a range but since the market doesn’t seem to ever do that we need to be ready.
The list of adjustments I would make is relatively small. The options at your disposal trading this way truly are exponential. However, I prefer the keep it simple approach so here is what I would do.
Adjustment #1
- Close the two most profitable contracts with the two smallest loss contracts.
- Typically this will secure a profit on these two trades. Leaving us only to rectify the losing trade that remains. Below is an image, using the example trade above, of what I’m saying.
You can see highlighted in green by doing this we would immediately lock in a gain of $167.50. However, we still have the problem of the calendar trade that has just been turned into a diagonal spread and is currently a large loss. We must address that immediately. Failing to adjust that trade leaves all of the risk on the table with the wide diagonal that remains. Admittedly, if you’re willing to accept the remaining risk you could just leave the trade alone but I myself probably wouldn’t.
Adjustment #2
- Turn the remaining position into a broken wing butterfly or a standard butterfly.
- Take notice that all we want to do here is minimize or eliminate the existing loss because we’ve already secured some profit. The goal now is to minimize this loss. To turn the position into a BWB you’ll need to close one leg of the spread. I would choose to close the nearer expiration contract to give myself time but either way can be successful.
Closing Thoughts
Well, in this case we were able to avoid any further loss by rolling into a broken wing butterfly with a bearish bias. Should the market have continued the relentless climb we would have been forced to take a loss or adjust the position again.
The truth is, once you identify the adjustments you prefer the trade can be salvaged. Generally by removing over half of the initial risk, which is nice. In this case I opened a $5 wide BWB which did leave a considerable amount of risk on the table but I wanted to be sure we were able to overcome the sizeable loss. Further, for the sake of this post I allowed the trade to run longer than I would have in real time. I would typically adjust this after only a few days if the market was running fast. Basically meaning, I wouldn’t have had to overcome such a large loss.
In all, like most options strategies, it can and will work. However, it can and will also fail. Had I pulled up into a bullish BWB I could have been looking at an even larger loss. My options then would have been to adjust or accept the loss and move on.
In any case, I hope you enjoyed learning the 3-way calendar spread options strategy and I look forward to hearing any thoughts you have in the comments below. Also, below is an image of how this trade turned out for those that are interested.
God bless,
Jeff
