Diagonal Spreads: Setup, Risks, and Uses TradeKing is a member of FINRA & SIPC August 23, 2011
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Diagonal Spreads: Setup, Risks, and Uses TradeKing is a member of FINRA & SIPC August 23, 2011
Long Diagonal Spreads: Setup, Risks, and Uses Diagonal Spreads Intro
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
Quote Board and Spreads Strikes JAN FEB MAR 100 95 90 85 80 75 70 7
Quote Board and Spreads Strikes JAN FEB MAR 100 Sell 95 Buy 90 85 80 75 70 Vertical Spread 8 8
Quote Board and Spreads Strikes JAN FEB MAR 100 Sell 95 Buy 90 Sell Buy Horizontal Spread 85 80 75 70 9 9
Quote Board and Spreads Strikes JAN FEB MAR 100 Sell 95 Buy 90 Sell Buy 85 Buy Diagonal Spread 80 Sell 75 70 10 10
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
Long Diagonal Spreads: Setup, Risks, and Uses Diagonal Spread Examples
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. XYZ @ 128.66 Buy 1 XYZ 543-day 100 Call @ 35.30 Delta.77 Sell 1 XYZ 60-day 135 Call @ 1.90 Delta -.29 Net Debit 33.40 At front month expiration: Max Risk 33.40 Max Gain??? Limited but unknown Commission $6.25 13
Delta/Gamma Risk Delta: Non-Textbook Definition The delta is the probability of the option being in the money on expiration. Stock @ 50 Call Strike is 50 51 1) One Day to Expiration.50.90 2) Sixty Days to Expiration.50.60 14
Diagonal Call Spread LMN @ 126.13 Buy 1 61-Day (Sep) 130 Call @ 2.60 Sell 1 26-Day (Aug) 128 Call @ 2.00 Net Debit.60 Commission $6.25 At front month expiration: Max Risk 2.60 Max Gain??? Limited but unknown Additional Requirement = $2 (130 128) or $200 15
Diagonal Put Spread ABC @ 106.75 Buy 1 61-Day (Sep) 105 Put @ 7.90 Delta -.43 Sell 1 26-Day (Aug) 95 Put @ 1.45 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 = $1.82 16
Long Diagonal Spreads: Setup, Risks, and Uses Diagonal Spread Criteria
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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