Option Strategies
Option Trading Strategies

Bullish Strategies

  • A Long Call Diagonal Spread is constructed by purchasing a call far out in time, and selling a near term call on a further OTM strike to reduce cost basis. This trade has only two legs, but it gives the effect of a long vertical spread in terms of directionality, and a calendar spread in terms of its positive vega. This results in a bullish position that can benefit from an increase in implied volatility. A Long Call Diagonal Spread is usually used to replicate a covered call position. 

– Buy an in-the-money (ITM) call option in a longer-term expiration cycle (Expiration 2) 

– Sell an out-of-the-money (OTM) call option in a near-term expiration cycle (Expiration 1) 

  

The trade will be entered for a debit. It’s important that the debit paid is no more than 75% of the width of the strikes. 

  

Example: 

XYZ Stock at $100 

Purchase (Expiration 2) 90 call for $15 

Sell (Expiration 1) 110 call for $5 

Net debit = $10.00 on a 20-point-wide long call diagonal spread 

 

The setup of a diagonal spread is very important.  

 

If we have a bad setup, we can actually set ourselves up to lose money if the trade moves in our direction too fast.  

 

To ensure we have a good setup, we check the extrinsic value of our longer dated ITM option. 

 

Once we figure that value, we ensure that the near term option we sell is equal to or greater than that amount.  

 

The deeper ITM our long option is, the easier this setup is to obtain. We also ensure that the total debit paid is not more than 75% of the width of the strikes. 

 

  

 

We never route diagonal spreads in volatility instruments. Each expiration acts as its own underlying, so our max loss is not defined. 

Max Profit: The exact maximum profit potential cannot be calculated due to the differing expiration cycles used. However, the profit potential can be estimated with the following formula: 

Width of call strikes – net debit paid 

How to Calculate Breakeven(s): The break-even cannot be calculated due to the differing expiration cycles used in the trade. As a rough estimate, the break-even area can be approximated with the following formula: 

Long call strike price + net debit paid 

 When do we close Diagonal Spreads? 

We generally look for 25-50% of max profit when closing diagonal spreads. Profit occurs when the long option moves further ITM and gains value, and/or if implied volatility increases. 

When do we manage Diagonal Spreads? 

We manage diagonal spreads when the stock price moves against our spread. In this case, we look to roll down the short option closer to the breakeven price, so that we can collect more premium and reduce our overall risk.  

You need to carry an options contract to its expiration

Trades cannot be adjusted since there is a contract

Wide strikes that offer more premium and therefore profit is good

 

Common Strategies

Short and Long Calls

Short and Long Puts

Credit Spreads

Debit Spreads

Long Strangles

Long Straddles

Iron Condor

Short Straddles

Short Strangles

Iron Butterfly

Iron Fly

Diagonal Spreads

Diagonal Calendar Spreads

Box Spreads

Bullish Strategies

Bearish Strategies

Neutral Strategies

Trade Adjustments

Keys to understanding options

Indicators

Building Blocks

Greeks

Implied Volatility

The Mark

Trade Management

Common Indicators

Resistance

Support

MACD

RSI

Volume

Moving Average

What you need to know on every trade

Market direction

Maximum Profit

Maximum Loss

Break Even

The Mark

Implied Volatility

Exit Strategy

Trading Platforms

Think or Swim

Trading Station

Robinhood

Tasty Works

We Bull

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