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A double diagonal spread combines a diagonal bull call spread with a diagonal bear put spread in an effort to profit from minimal volatility in the underlying security – at first.
After the initial options expire, there are actually a number of ways of profiting from the strategy.
Let’s look at how the trade is set before we delve into the various money-making possibilities that derive from it.
A Four-Legged Animal
What’s the composition of the double diagonal spread? On the call side, the trader sells a near-month, out-of-the-money call and simultaneously buys another, later-dated, further out-of-the-money call.
And on the put side, a mirror image: sell the near-month, out-of-the-money put and buy a later-dated, further out-of-the-money put.
The trade therefore has four legs and should be constructed such that the short call strike is higher than the short put strike. How far above will be determined by how confident the trader is that the underlying will close between the two strikes by the first expiry. Remember, too, that the closer the two are to one another, the greater the credit to be had from them.
Below is an example from the real world, offered to better appreciate all the trade’s profit possibilities.
This is a chart of Pittsburgh Plate Glass Inc. (NYSE: PPG) during a period of relatively little volatility.
For better than half a year the stock bounced between $110 and $118. As early as February you expect this and decide to initiate a double diagonal spread (red circle). With the stock at $114, you sell the March 116 call for $2.50 and buy the June 118 for $2.85. Total debit on the call side is $0.35.
On the put side, you sell the March 112 put for $2.60 and buy the June 110 for $2.90. Total debit here is $0.30, for an overall debit of $0.65 (all strikes boxed in black).
Early Fright, Later Delight
Within days the stock moves sharply higher, and you toy with the idea of shutting down at least the call side of the trade. But your patience pays off as the stock soon settles back into the middle of its range and the short options expire worthless, with the stock at $113.10 (blue circle).
You now have a three-month open sail with two long options (at very little cost) and a number of profit possibilities.
- You could wait until the stock makes a strong move in either direction, sending either your call or put into the money by at least $0.65 by expiry; or
- You could sell the call and put immediately upon expiration of the short options, hauling in whatever time value still remained on the pair.
With no great hope that the stock will break out of its range over the next few months – and the long call and put valued at $1.65 and $2.20 respectively – you choose to close.
Your total profit for the trade is $320 ([$1.65 + $2.20 – $0.65] x 100).
Cutting Early vs. Holding Out
Maximum payoff for the double diagonal spread is not easily calculated. If the stock remains within a tight range for the entire length of the trade (something we can’t know beforehand), early closure is best, so that maximum time value can be gotten for the long pair.
Maximum losses occur when the stock moves sharply at the outset, putting the short options deep in the money for a substantial loss, only to return to range by the time the long options expire, rendering that pair worthless.
You won’t find this anywhere else
You’ll never read about this powerful trading strategy in the Wall Street Journal. Or see it discussed on CNBC. 99 out of 100 brokers know nothing about it. Yet this nearly risk-free trading system has been able to turn $330 into $3,300. And it’s been put together by one man who wants to share its secrets with you. Discover them right here.