For this Playbook, I’m using the example of one-month diagonal spreads. I say usually, because you’ll see further down in this post why it can be really important to understand gamma risk. Short puts would generally only get assigned if they are in-the-money and there is very little time value left. You can mitigate this risk by trading Index options, but they are more expensive. By using a random number generator it makes it completely random and means I haven’t cherry picked the best entry point. For example, if BA rises above $230, the trade actually flips to be slightly negative delta, because the trader wants the stock to head back down towards the profit zone as the trade gets closer to expiry. As with all trading strategies, it’s important to plan out in advance exactly how you are going to manage the trade in any scenario. If the stock drops, the maximum loss on the downside is equal to the difference in the strike prices plus / minus the option premium paid / received. Don’t have an Ally Invest account? The goal is minimal volatility at first. However, you could potentially run into a scenario where volatility in the front month rises (bad for the short put) and volatility in the back month drops (bad for the long put). This is due to changes in implied volatility. This means that for every 1% rise in implied volatility, the trade should gain $6. As the trade progresses, the delta will change. Short Diagonal Calendar Put Spread - Introduction The Short Diagonal Calendar Put Spread, also known as the Short Calendar Diagonal Put Spread, is a volatile options strategy that profits when the underlying stock breaks out either to upside or downside. Your email address will not be published. View all Forex disclosures, Forex, options and other leveraged products involve significant risk of loss and may not be suitable for all investors. If you’re going to use more than a one-month interval between the front-month and back-month options, you need to understand the ins and outs of rolling an option position. The best we can do is use our broker platform or software such as Option Net Explorer to estimate the maximum gain. Diagonal spreads are long vega trades, so generally speaking they benefit from rising volatility after the trade has been placed. NOTE: This graph assumes the strategy was established for a net debit. The rationale behind the diagonal ratio spread is to pay for the longer-term options with the shorter. It can take advantage of differential erosion by time to expiration, as we discussed in Chapter 6 when we examined A short diagonal spread with puts is created by selling one “longer-term” put with a higher strike price and buying one “shorter-term” put with a lower strike price. A calendar spread consists of two options that are the same type (put or call) and have the same strike price, but have different expirations. To reduce assignment risk consider closing your trade if short put is close to being in-the-money, particularly if it is close to expiry. After the strategy is established, although you want neutral movement on the stock if it’s at or above strike B, you’re better off if implied volatility increases close to front-month expiration. Diagonal spread options strategy. For step one, you want the stock price to stay at or around strike B until expiration of the front-month option. 8) Be aware of ex-dividend dates as the shorted side of call calendar/diagonal spread can become an exercise on you the day before the ex-dividend date, and the put … That might be 10% of capital at risk or you may plan on holding to expiration provided the stock stays within the profit tent. Because there are two expiration dates for the options in a diagonal spread, a pricing model must be used to “guesstimate” what the value of the back-month call will be when the front-month call expires. A diagonal put spread is created when long term put options are bought and near term put options with a higher strike price are sold. If your forecast was correct and the stock price is approaching or above strike B, you want implied volatility to decrease. I could have closed the trade for around 10% profit instead of 4-5%. D iagonal spreads are similar to calendar spreads as a diagonal spread consists of a long and short position in option contracts sharing the same underlying.