Subject: Making Adjustments to Calendar and Diagonal Spreads

 

Terrys Tips newsletter
     

Dear Friend,

If you missed it last week, be sure to check out the short video which explains why I like calendar spreads.  This week I have followed it up with a second video entitled How to Make Adjustments to Calendar and Diagonal Spreads.

I hope you will enjoy both videos.  I also hope you will sign up for a Terry’s Tips insider subscription and start enjoying exceptional investment returns along with us (through the Auto-Trade program at thinkorswim).

Terry

 
Option Tip of the Week

Making Adjustments to Calendar and Diagonal Spreads:  

When we set up a portfolio using calendar spreads, we create a risk profile graph using the Analyze Tab on the free thinkorswim trading platform.  The most important part of this graph is the break-even range for the stock price for the day when the shortest option series expires.  If the actual stock price fluctuates dangerously close to either end of the break-even range, action is usually required.

The simple explanation of what adjustments need to be made is that if the stock has risen and is threatening to move beyond the upside limit of the break-even range, we need to replace the short calls with calls at a higher strike price.  If the stock falls so that the lower end of the break-even range is threatened to be breached, we need to replace the short calls with calls at a lower strike.  

There are several ways in which you can make these adjustments if the stock has moved uncomfortably higher:

1. Sell the lowest-strike calendar spread and buy a new calendar spread at a higher strike price, again checking with the risk profile graph to see if you are comfortable with the new break-even range that will be created.  The calendar spread you are buying will most likely cost more than the calendar spread you are selling, so a small amount of new capital will be required to make this adjustment.

2. Buy a vertical call spread, buying the lowest-strike short call and selling a higher-strike call in the same options series (weekly or monthly).  This will require a much greater additional investment.

3. Sell a diagonal spread, buying the lowest-strike short call and selling a higher-strike call at a further-out option series.  This will require putting in much less new money than buying a vertical spread.

4. If you have a fixed amount of money to work with, as we do in the Terry’s Tips portfolios, you may have to reduce the number of calendar spreads you own in order to come up with the necessary cash to make the required investment to maintain a satisfactory risk profile graph.

There are similar ways in which you can make these adjustments if the stock has moved uncomfortably lower.  However, the adjustment choices are more complicated because if you try to sell calls at a lower strike price than the long positions you hold, a maintenance requirement comes into play.  Here are the options you might consider when the stock has fallen:

1. Sell the highest-strike calendar spread and buy a new calendar spread at a lower strike price, again checking with the risk profile graph to see if you are comfortable with the new break-even range that will be created.  The calendar spread you are buying will most likely cost more than the calendar spread you are selling, so a small amount of new capital will be required to make this adjustment.

2. Sell a vertical call spread, buying the highest-strike short call and selling a lower-strike call in the same options series (weekly or monthly).  This will require a much greater additional investment.  Since the long call is at a higher strike price than the new lower-strike call you sell, there will be a $100 maintenance requirement per contract per dollar of difference between the strike price of the long and short calls.  This requirement is reduced by the amount of cash you collect from selling the vertical spread.

3. Sell a diagonal spread, buying the highest-strike short call and selling a lower-strike call at a further-out option series.  This will require putting in much less new money than selling a vertical spread.
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Any questions?   I would love to hear from you by email (terry@terrystips.com), or if you would like to talk to our guy Seth, give him a jingle at 800-803-4595 and either ask him your question(s) or give him your thoughts. seth@terrystips.com

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I look forward to having you on board, and to prospering with you.

Terry

 


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Overbought/Oversold report
October 29, 2015
• S&P 500 (SPY) – 68.1 (Neutral)
• Dow Jones (DIA) – 62.2 (Neutral)
• Russell 2000 (IWM) – 60.1 (Neutral)
• NASDAQ 100 (QQQ) – 74.5 (Neutral)     
 
Testimonial of the Week

" I have done very well with your XIV recommendations..... originally bought many shares in the 5 - 5.50 range and just sold them at 8, so you  were right on! Thank you again!”   ~ Bob 

(Note from Terry: Six months after Bob wrote this message, those shares were trading over $20, and I still owned mine.  By the way, it was the only stock purchase I recommended for the entire year.)

     

Thank you again for being a part of the Terry's Tips newsletter. If you are interested in signing up as an Insider, visit Terry's Tips today for details.

Sincerely,
Dr. Terry Allen
Terry's Tips

 
 
Week 369

October 29, 2015
 
In This Issue
Option Trading Idea of the Week
Overbought/Sold Condition Report
Testimonial of the Week
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