Option adjustment is a huge subject onto itself. Each strategy generates trading rules of its own in the Sheridan methodology. Here’s how he handles one of the most common — the calendar spread, when the underlying moves against the strategist.
calendar spread, same strike (50), to a diagonal spread (long 50, short 52.50). You did this because your forecast is now bullish. (By this time, you have changed from a delta-neutral strategy, no movement, to a directional strategy, with a differ- ent risk-reward ratio and a different risk curve as well.)
1. Add a calendar. After putting on a calendar spread, you would be pleased if it sat there and did nothing until expiration. Unfortunately, stocks don’t do this, and it takes a bit of skill to earn your profit. So when you reach the next strike, up or down, you can consider adding another calendar. This will bring you back to breakeven or even allow you to squeeze out a small profit.
2. Partial repositioning. When the underlying has moved sufficiently for you to reach breakeven on the risk curve, you can reposition. On the move up, your delta has gone from zero, say, to -30. Say you have 10 50 calendars; take five off at 50 and put five back on at 52.50. You have likely cut your deltas now in half, to -15. If the stock starts moving sideways again, this will bring you back to breakeven, or even allow you to squeeze out a small profit. Forecast recap: slightly bullish, split decision between two strikes, 50 and 52.50.
3. Full repositioning. Say you are more bullish than that. The stock has moved up for a reason, and you agree it’s worth more. Say again you have 10 50 calendars. Take all 10 off at 50 and put 10 back on at 52.50. Your -30 delta is now back to zero or thereabouts. Again, if the stock starts moving sideways again, this will create a profit opportunity. Forecast: more bullish, you have changed your opinion that the stock is now worth 52.50, not 50.
5. Roll down. Say you become straight-out bearish — take in your short option and roll it down — that is, sell the next strike in the direction of the move. If you are calendar-spread at 50 and the stock decreases, buy in your short 50, and sell the 47.50 or 45 strike. Keep the 50 strike call. You are now short deltas, probably moving from -30 delta to -50 delta or so. You are also now diagonally spread — you have gone from a calendar spread, same strike (50), to a diagonal spread (long 50, short 47.50 or 45). You did this because your forecast is now bearish. (By this time, you have changed from a delta- neutral strategy — that is, no movement, to a directional strategy, with a different risk-reward ratio and a different risk curve as well.)
6. Closeout. If there is a material change in the situation of the underlying and you are truly confused, close the trade. Even a large move against you by this time will likely create only a small loss. Worst case: your initial debit — that is, if you put on a calendar spread for $0.40, that’s the most you can lose.
7. When to take profit. Target a 20% yield. When that level is reached, take off the calendar when profit slips back a bit — that is, when it declines to 17%. At that point, either take the entire position off or roll the front month to the next. Go by the yield, don’t hang around to see what the market gives you. That’s the professional way to trade: yield.
4. Roll up. Let’s say you become straight-out bullish. Take in your short option and roll it up — that is, sell the next strike in the direction of the move. If you are calendar-spread at 50 and the stock increases, buy in your short 50 and sell the 52.50 strike. Keep the 50 strike call. You are now long deltas, in our example here, moving from -30 delta to +15 or +30 delta. You are now diagonally spread — that is, you have gone from a
If a calendar costs you $2,000, and you are up $400 in two weeks, protect your profit now above all else. Watch your profit like a hawk now that you have one — not deltas, thetas, stock price, or anything else. You are protecting your profit. If trade profit on a $2,000 calendar — once $400 — now declines to $340, exit, take your gain, thank the trading gods, move on, redeploy funds. That’s it.
$7,000 out of a possible $9,810, so that’s approximately 71% of the maxi- mum amount you could have received on this trade. This is all I want out of a trade. I never carry a trade into expira- tion week — the delta and gamma risk are way too high for me.
erything in trading is a tradeoff.
Which broker do you use?
Thinkorswim. They have an excel- lent platform, excellent customer ser- vice, and a willingness to help.
Any final comments?
What size do you trade?
In a given month, I might have on positions on the Russell 2000 index (RUT), iShare Russell 200 index (IWM), Diamond (DIA), NASDAQ 100 exchange traded fund (QQQ), S&P 500 Deposi- tary Receipts (SPY), and maybe 20 to 30 contracts or so in each — so that’s an average of 100 to 150 contracts at a time.
You can’t overemphasize the impor- tance of a good mentor. Dan Sheridan teaches how to trade — to learn the craft, as he would say. The real strengths of his program are his emphasis on risk management and his desire that each student become a successful trader. Trading options for a living is hard work, but it’s nice to know you have someone to call if you have a question.
So that would be 10-point strikes in RUT?
Dan Sheridan’s website and commu- nity came after my time with him, but even as one of Sheridan’s early stu- dents, I still have access to the website and all its features. Trading can be a lonely business, and having someone to
No, 20. It generates a little bigger credit, but at the cost of higher margin, and a higher theoretical risk, too. Ev-
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talk to and share ideas and thoughts with is a great help. This is what the Sheridan community provides.
John Sarkett is the developer of Option Wizard Scan and Scan Wizard software (http://option-wizard.com).
RELATED READING Sarkett, John A. . “Calendar Spreads With Dan Sheridan,” Tech- nical Analysis of STOCKS & COM- MODITIES, Volume 25: May. _____ . “Double Calendars And Condors,” Technical Analysis of STOCKS & COMMODITIES, Volume 25: June. _____ . “Double Diagonals And Butterfly Spreads,” Technical Analy- sis of STOCKS & COMMODITIES,
Volume 25: July . S&C