Also, notice the profit and loss lines are not straight. Straight lines and hard angles usually indicate that all options in the strategy have the same expiration date.
The Strategy You can think of this as a two-step strategy. It starts out as a time decay play. Then once you sell a second call with strike A after front-month expirationyou have legged into a short call spread.
- Diagonal Spreads Explained | The Options & Futures Guide
- Appropriate market forecast A long diagonal spread with calls realizes its maximum profit if the stock price equals the strike price of the short call on the expiration date of the short call.
- 15 Rules for Calendar/Diagonal Spreads - TheStreet
Ideally, you will be able to establish this strategy for a net credit or for a small net debit. Then, the sale diagonal spread in options the second call will be all gravy. But please note, it is possible to use different time intervals.
Options Guy's Tips Ideally, you want some initial volatility with some predictability. Some volatility is good, because the plan is to sell two options, and you want to get as much as possible for them. On the other hand, we want the stock price to remain relatively stable.
To run this strategy, you need to know how to manage the risk of early assignment on your short real earnings on the Internet money withdrawal. The Setup Sell an out-of-the-money call, strike price A approx.
Break-even at Expiration It is possible to approximate break-even points, but there are too many variables to give an exact formula. The Sweet Spot For step one, you want the stock price to stay at or around strike A until expiration of the front-month option.
Maximum Potential Profit Potential profit is limited to the net credit received for selling both calls with strike A, minus the premium paid for the call with strike B.
Maximum Potential Loss If established for a net credit, risk is limited to the difference between strike A and strike B, minus the net credit received.
If established for a net debit, risk diagonal spread in options limited to the difference between strike A and strike B, plus the net debit paid. Ally Invest Margin Requirement Margin requirement is the difference between the strike prices if the position is closed at expiration of the front-month option. NOTE: If established for a net credit, the proceeds may be applied to the initial margin requirement.
Keep in mind this requirement is on a per-unit basis.
As Time Goes By For this strategy, before front-month expiration, time decay is your friend, since the shorter-term call will lose time value faster than the longer-term call. After closing the front-month call with strike A and selling another call with strike A that has the same expiration as the back-month call with strike B, time decay is somewhat neutral.
That way, you will receive a higher premium for selling another call at strike A. After front-month expiration, you have legged into a short call spread. So the effect of implied volatility depends on where the stock is relative to your strike prices.
If your forecast was correct and the stock price is approaching or below strike A, you want implied volatility to decrease. If your forecast was incorrect and the stock price is approaching or above strike B, you want implied volatility to increase for two reasons. First, it will increase the value of the near-the-money option you bought faster than the in-the-money option you sold, thereby decreasing the overall value of the spread.
Two Invaluable Tips for Diagonal Spreads
Second, it reflects an increased probability of a price swing which will hopefully be to the downside.