Vertical adjustments on calendar spreads can be a very effective risk management tool. With contango and backwardation going back and forth in the market using a containment calendar strategy can be very profitable.
Click here or in the video below to discover all the secrets to this trade!
00:00 S&P 500
05:00 Vertical spread
07:00 Positive Delta
07:30 Make money
07:40 Delta definition
08:35 Risk management
12:30 Risk management
14:35 Trade win
We’re in the SPX. This is going to be a $25,000 planned capital trade with a 20% profit target. It’s 30-day trade in the front and there’s going to be a 14 day spread to the back. You got a 200 point range with that tent. It’s obviously sending a little bit positive Delta.
I’m going to use a front month vertical adjustment strategy to correct my Delta. And I am going to use Delta parameters to control my trade and control my risk.
The highlight that I want to make is that during this campaign IV rises and then it falls while the horizontal skew starts out as flat and then moves to contango. Meaning it’s not in backwardation.
Contango is when the front month IV is lower than the back. And for some people that are a little more advanced with calendars, you have probably been taught that backwardation, meaning the front month implied volatility is higher than the back is optimal. While it certainly can be very advantageous when used correctly, it’s not a requirement for success.
This trade actually starts out with what I call flat skew or slightly in contango.
What I want to do is set the trade to try to take advantage of the market being like a magnet and coming back to these prior basing areas, the consolidation zones.
I want to be strict with my parameters by using Delta triggers because if the market takes off aggressively to the upside or it collapse to the downside, I don’t want to sit in for that.
I’m trying to make 20% on $25,000. I like to keep my loss at one to one with what I’m trying to make. So I would use an absolute max loss of 20%, but really, I would punch out of this trade if it drew down probably around 10%.
I want to give people an idea how you might construct a trade or at least think about how it’s going to behave.
All I simply did was move half of these strikes down to cut that Delta more towards neutral or reduce the positive Delta. Just trying to balance it out and keep it towards the center of the tent as the market tries to consolidate.
I’m going to roll some of these shorts up. Half of them. This is a real simple strategy as you can see. I’m keeping it simple by rolling half at a time and not ones or twos or sixes as I want to keep it real simple and not complicate things. Cutting the Delta roughly in half.
Why is too much Delta bad for the trade?
First of all that would be situationally specific. That’s just the way I set up this trade. You don’t need a Delta limit or Delta triggers. It’s just that with the context that I entered this trade, I wanted to take advantage of a consolidation in the market.
If you just trade a calendar by itself it’s a containment strategy. As long as the market stays in some sort of a range I’m going to make money. I’m “containing it”
What is Delta?
Delta is the software’s estimated value value change in this position over the next one dollar of price movement in the asset. Which changes according to Gamma.
Gamma changes every time every anything else changes. And these Delta numbers also change anytime extrinsic value changes due to supply and demand. All your numbers change. All your Greeks change. Then the software model has to recalculate what’s going on. That’s why the t-plus zero line is moving all over the place and is changing throughout the day, and changes from day to day.
But Delta just gives us a general idea of how much price risk we have in the position and, if we choose to do so within our strategy, we can use that as a trigger. In this particular trade, we use Delta as a trigger.
We want to use flatter Delta as a trigger in trending markets. We want to maybe ignore Delta in verry choppy markets. It’s a risk management tool.
Lose the trade
We are always determining under which conditions we’re willing to lose the trade and to what extent whether we realize it or not. Most people are saying, I just want to win the trade regardless of whatever happens but believing that is ignorance. Regardless of the strategy, there is a risk of loss, and that risk is defined by the trading rules. If you are trading in an educated manner, you are purposefully choosing under which types of conditions you’re willing to lose the trade.
If you are interested in seeing a lot more about calendar spreads: