Diagonal Spreads:
This Isn’t Your
Father’s Covered Call.
DIAGONAL SPREADS
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Strategy 1:
Buy condo & work
on suntan. “Buy &
Hold”
Strategy 2:
Buy condo and
lease out to retirees.
“Covered Call”
Strategy 3: Lease
condo and rent out
to tourists.
“Diagonal Spread”
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DEFINITION OF A
DIAGONAL SPREAD
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An multi-leg option strategy in which an
owner of a longer-term call option sells a
shorter-term, higher strike call option to take
advantage of variations in time value (high
Theta) and volatility pricing (high Vega). It is
often used during periods of short-term
market neutrality when a trader is long-term
neutral/bullish on a stock/ETF or index.
DIAGONAL SPREADS
PROS AND CONS
PROS
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CONS
Profit if stock goes up or sideways
May give up large profits
Reduced downside equity risk
Gamma Risk
Income from short leg: weekly/monthly
Dividend Risk*
Time decay works in your favor
Additional maintenance/fees of position
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SPY Options Chain 2/25/17
DIAGONAL SPREAD
STEP BY STEP
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1. Buythecall(longerterm,ITM*)
2. Sellcall(Shorterterm,OTM*)
2-steptrade
3. Pricerises>Strike– buycallbackor“roll”
4. Pricedrops/stayssame– Allowshortlegtoexpire
&repeatsteps2-4ORclosepositionOR“Roll”
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BUYING CALL (LONG LEG)
STEP #1:
Current price is $100.00. Buy 1 Contract one
year 85 strike @$18.30 (.70 Delta, -.009
Theta) $1,830 + commission
Current Price
$100
BUY 1 contract 1 year 85 strike $1,830
EXPIRY 365
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SELLING THE CALL (SHORT LEG)
STEP #2:
Current price is $100. Sell 1 contract of next month’s 105 strike
for $1.50 (.25 Delta). 30 days to expiration (-.05 Theta). Credit
$150
SELL 1 call contract 1 month, 105
strike $150 credit
EXPIRY 30
Current Price
$100
BUY 1 call contract 1 year 85 strike $1,830
EXPIRY 365
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MANAGING THE TRADE
SCENARIO #1:
Over the 30 days the stock price increases to
$103. What’s the value of the short leg?
What’s the value of the long leg? What do
you do?
Next
Month’s
$110 Call
@ $1.60
EXPIRY 30
Current Price
$105
BUY 1 call contract 1 year 85 strike $1,830
EXPIRY 365
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MANAGING THE TRADE
SCENARIO #2:
Over the 30 days the stock price remains at
$100. What’s the value of the short leg?
What’s the value of the long leg? What do
you do?
Next
Month’s
$105 Call
@ $1.20
EXPIRY 30
Current Price
$100
BUY 1 call contract 1 year 85 strike $1,830
EXPIRY 365
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MANAGING THE TRADE
SCENARIO #3:
Over the 30 days the stock price falls to $95.
What’s the value of the short leg? What’s the
value of the long leg? What do you do?
EXPIRY 30
Current Price
$95
Next
Month’s
$100 Call
@ $1.50
Next
Month’s
$95 call
@ $3.50
Next
Month’s
$90 Call
@ $8
BUY 1 call contract 1 year 85 strike $1,830
EXPIRY 365
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MANAGING THE TRADE
SCENARIO #4:
Over the 30 days the stock price has
increased to $110 30 minutes to
market close. What’s the value of the
short leg? What’s the value of the
long leg? What are your choices?
Current Price
$110
EXPIRY 30
This
Month’s
$105 Call
@ $5.10
Next
Month’s
$105 call
@ $6.00
Next
Month’s
$110 Call
@ $3
BUY 1 call contract 1 year 85 strike $1,830
EXPIRY 365
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1925 = +$446/day
1930 = $394/day
1925 = +$140/day
1930 = $132/day
1900 -$22 Intrinsic
= ($35/day)
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SPX Effects of time on value
1925 = +$446/day
1930 = $394/day
1925 = +$140/day
1930 = $132/day
1900 -$22 Intrinsic
= ($35/day)
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SPX Effects of time on value
1925 = +$446/day
1930 = $394/day
1925 = +$140/day
1930 = $132/day
1900 -$22 Intrinsic
= ($35/day)
1.8% Yield/8 Days + Potential Price Appreciation
GLD Diagonal Spread
The Position Greeks.
Greeks
LongLeg
Jan18,19
694Days
Short Leg
March3,17
8Days
NetGreeks
Long- Short
Delta
.64
(.21)
430
Gamma
.0130
(.121)
(109)
Theta
(.007)
.043
36
Vega
.617
(.052)
565
RHO
1.174
(.005)
1,169
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DIAGONALS IN AN INDEX
S&P 500 (SPX) Characteristics
1. Cashvs.PhysicalSettlement
2. Europeanvs.AmericanStyleExercise/Assign
3. Weekly:expiration,lasttrade4:00Est.vs.4:15
4. Monthly:expirations,SETValues,lasttrade4:00
Est.vs.4:15
Diagonal Spreads:
This Isn’t Your
Father’s Covered Call.