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Adjusting Calendar Spreads - An Example in FXE Options

A few days ago, the Euro ripped higher on news that more money would be thrown at the debt crisis.

But in the past 2 days, the $EURUSD has made a multi standard deviation move to the downside.

Last week I took a look at an $FXE calendar spread trade that made money if the Euro made a decent move to the downside, and it's now profitable.

Here was the original trade:

The current price for that spread is now 1.10, so the trade has an unrealized gain of .30, or 37% return on risk.

Here is the current risk profile, courtesy of thinkorswim:

The trade is in what I call the "sweet spot" of a calendar, but the risk you now have is if the market continues to make sharp movements.

Many traders that are bearish on$FXE will probably want to remain bearish. So consider this adjustment:

This trade adjustment is what I call a "cal-vert stairstep." You are rolling the short option from the front month to the next month. This can also be considered a "diagonal roll."

All this does is simply convert your put calendar into a bear put spread.

Here are the tradeoffs:

1. You decrease your risk from .80 per spread to .10 per spread

2. You lose the positive theta component of the trade

3. You add more short deltas against the trade

4. You eliminate the short gamma component

Here is what the trade looks like after this adjustment:

This kind of risk management strategy is a great tool for option traders as it lets you stay in a trade while taking money off the table. Ideally you would then get a move lower over time, and then you could roll the vertical back to a calendar.

The cal-vert stairstep is one of the more advanced tactics that is covered in OptionFu, my options training course. Over 25 hours of high quality video-- it will make you a better options trader, guaranteed.

by Steven Place

Steven Place is the founder and head trader at investingwithoptions.com/