Diagonal Spreads: Setup, Risks, and Uses. TradeKing is a member of FINRA & SIPC

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1 Diagonal Spreads: Setup, Risks, and Uses TradeKing is a member of FINRA & SIPC August 23, 2011

2 Disclaimer Options involve risks and are not suitable for all investors. Prior to buying or selling options, an investor must receive a copy of Characteristics and Risks of Standardized Options, sent to you in previous communication. Additional copies may be obtained by calling TRADEKING at KING visiting or by downloading the file in the pop-up window on your screen. System response and access times may vary due to market conditions, system performance, and other factors. Multiple leg options strategies involve additional risks and multiple commissions, and may result in complex tax treatments. Please consult a tax advisor. Any strategies discussed and examples using actual securities and price data are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation, or solicitation to buy or sell securities. Past performance is not a guarantee of future results. Consider the following when making an investment decision: your financial situation, your risk profile and transaction costs. The projections or other information generated by TradeKing's tools regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. The calculations do not take into consideration all costs, such as commissions and margin interest which may impact the results shown. It is the user's sole responsibility to select the criteria to enter in the TradeKing's tools, or to choose among the pre-defined screens, and to evaluate the merits and risks associated with the use of the tools before making any investment decisions. TradeKing is not responsible for any losses that occur from such investment decisions. 2

3 Disclaimer Market timing is a complex investment strategy which involves risk and may incur additional commission costs. Delta represents the consensus of the marketplace as to the theoretical price movement of the option relative to the underlying security. Gamma represents the consensus of the marketplace as to the theoretical rate of change of Delta relative to the underlying security. Theta represents the consensus of the marketplace as to the amount a theoretical option's price will change for a corresponding one-unit (day) change in the days to expiration of the option contract. Implied volatility represents the consensus of the marketplace as to the future level of stock price volatility. There is no guarantee thatt these forecasts will be correct. TradeKing charges $4.95 for equity and option trades, add 65 cents per option contract. Trade more than 8 contracts, and we'll automatically lower your cost to 15 cents per contract plus $8.95 per trade. TradeKing charges an additional $0.35 per contract on certain index products where the exchange charges fees. See our FAQ for details. TradeKing adds $0.01 per share on the entire order for stocks priced less than $1.00. See our Commissions + Fees page for commissions on low-priced stocks, option spreads, and other securities. Webinars are provided for educational and informational purposes p only. All investments involve risk, losses may exceed the principal invested, and the past performance of a security, industry, sector, market, or financial product does not guarantee future results or returns. TradeKing provides self-directed investors with discount brokerage services, and does not make recommendations or offer investment, financial, legal or tax advice. You alone are responsible for evaluating the merits and risks associated with the use of TradeKing's systems, services or products. 3

4 Diagonal Spreads: Setup, Risks, and Uses TradeKing is a member of FINRA & SIPC August 23, 2011

5 Long Diagonal Spreads: Setup, Risks, and Uses Diagonal Spreads Intro

6 Long Diagonal Spread A Long Diagonal Spread is the simultaneous sale of a near (front) term option and the purchase of a far (back) term option with different strike prices and of the same type (puts or calls). Long or short is determined by the calendar not the strikes. Long Call Diagonal Spread: Sell Aug 60 Calls, Buy Sept 65 Calls Long Put Diagonal Spread: Sell Aug 45 Puts, Buy Sept 40 Puts 6

7 Quote Board and Spreads Strikes JAN FEB MAR

8 Quote Board and Spreads Strikes JAN FEB MAR 100 Sell 95 Buy Vertical Spread 8 8

9 Quote Board and Spreads Strikes JAN FEB MAR 100 Sell 95 Buy 90 Sell Buy Horizontal Spread

10 Quote Board and Spreads Strikes JAN FEB MAR 100 Sell 95 Buy 90 Sell Buy 85 Buy Diagonal Spread 80 Sell

11 Quote Board and Spreads Strikes JAN FEB MAR 100 Sell 95 Buy 90 Sell Buy 85 Buy 80 Sell????? 75 Sell 70 Buy 11 11

12 Long Diagonal Spreads: Setup, Risks, and Uses Diagonal Spread Examples

13 Fig Leaf - Diagonal Call Spread Buy in-the-money (ITM) LEAPS call and Sell out-ofthe-money (OTM) near-term call against it. Just an elaborate covered call Buy 1 XYZ 543-day Delta.77 Sell 1 XYZ 60-day Delta -.29 Net Debit At front month expiration: Max Risk Max Gain??? Limited but unknown Commission $

14 Delta/Gamma Risk Delta: Non-Textbook Definition The delta is the probability of the option being in the money on expiration. 50 Call Strike is ) One Day to Expiration ) Sixty Days to Expiration

15 Diagonal Call Spread Buy 1 61-Day (Sep) Sell 1 26-Day (Aug) Net Debit.60 Commission $6.25 At front month expiration: Max Risk 2.60 Max Gain??? Limited but unknown Additional Requirement = $2 ( ) or $200 15

16 Diagonal Put Spread Buy 1 61-Day (Sep) Delta -.43 Sell 1 26-Day (Aug) Delta.18 Net Debit 6.45 Commission $6.25 Buying the higher strike put, so no additional risk beyond the debit paid - $6.45 max risk Theta on Sep 105 put is -.07, so 26 x.07 = $

17 Long Diagonal Spreads: Setup, Risks, and Uses Diagonal Spread Criteria

18 Long Diagonal Criteria Set profit and loss limits Close as spread when pertinent. If you choose to close, just the short position. You will be net long an option. No longer a spread trader. Go with the flow Might sell another option (ie. roll), might not. This trade can be customized to your outlook. Be aware of dividends and early assignment risk 18

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20 Thank you for your participation! Speaker: Brian Overby Audio Help: