In my previous post, I went over the basics of our calendar-spread income strategy. Now let’s look deeper into how we adjust for underlying price movement and changes in implied volatility, starting with an upside move.
Suppose we bought the SPY June/July 131/136 double-calendar on May 26, as described last time. Now imagine that SPY was trading over $135 yesterday (wishful thinking, I know), and the implied volatility index for SPY options had dropped by half a point. Our P/L curve would now look something like this:
Considering the net long vega of this position, the negative delta risk combined with the volatility risk suggests that an adjustment is in order. With implied volatility oversold, we’re in a good position to add another calendar position. Buying the SPY June/July 135/140 double-calendar brings our delta back in line with vega risk, resulting in the risk profile shown below:
We’ve brought delta back to the slight bullish bias we target, and added vega to help compensate for a rise in IV that should accompany any whipsaw reversal. What’s more, we’ve reduced gamma from about 3.2% of total capital at risk to about 2.4% and increased theta per dollar at risk from about 1.3% to approximately 1.76%.
The next installment in this series will look at downside adjustments.