The Complete Guide to Option Strategies by Michael Mullaney

Author:Michael Mullaney
Language: eng
Format: epub, mobi
Publisher: John Wiley & Sons, Ltd.
Published: 2010-05-11T04:00:00+00:00

Diagonalizing a Spread

Assume that XYZ stock is currently trading at $100 a share and you purchase an at-the-money call calendar spread, in which you sell a February 100 call for $5 and buy an April 100 call for $10. You are, in effect, buying the February/April 100 call time spread for a net debit of $5, or a total of $500. However, you may want to modify the position if you are slightly bullish on the stock, so you buy the April 95 call instead of the April 100 call. This modification increases your position delta, and you have diagonalized your position from a calendar spread to a diagonal spread. In a calendar spread, the options share the same strike price but have different expiration dates; however, in a diagonal spread, the strike prices also differ.

Practically any spread strategy can be converted (diagonalized) to a diagonal spread because a diagonal spread can be executed with many combinations of strike prices and expiration months. For example, a long February 100/105 vertical call spread can be diagonalized by offsetting the short February 105 call leg and replacing it with a short March 105 call. A diagonal spread in this chapter consists of options for which the strike prices and expiration dates are slightly different, such as if you were to buy one XYZ February 100 call and sell one XYZ March 105 call.

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