Double Diagonal Spreads

The double diagonal (DD) spread has come up for discussion in our live meetings. It is worthy of being considered as a stand alone strategy.

I must be certain the some points are understood before anyone tries to trade these DD spreads. This is NOT a trading strategy that I recommend for general use. It has certain characteristics that makes it suitable to use under some market conditions, but it can perform very poorly under other conditions.

To buy the double diagonal spread, a trader should believe

  • The underlying asset will trade within a specified range. This is due to the risk parameters of the embedded iron condor.
  • Implied volatility is likely to rise during the lifetime of the trade. This is due to the risk parameters of the embedded calendar spreads.

NOTE: This is NOT a good trade when you expect the implied volatility to soar due to a big market move. It is intended for a gentle stock market, but one in which IV rises. The double diagonal is also useful as a position to neutralize negative vega risk.

a) Most strategies that come up for repeated discussion are vertical spreads – and those are positions in which the long and short options expire at the same time. The only non-vertical spreads we have mentioned are the calendar and diagonal spread.

b) The diagonal spread consists of two options that expire at different times. The two options have different strike prices. Generally we tend to own the longer-term option. For that reason we will add to the definition of buying a diagonal spread: the trader owns the longer-term and sells the nearer-term option.

c) The diagonal spread consists of two calls or two puts. If we own a position with a diagonal put spread and a diagonal call spread, it it called a double diagonal.

If the two strike prices of a diagonal spread are identical, the position is a calendar spread, and not a diagonal.

d) The double diagonal is equivalent to an iron condor plus two calendar spreads. If you do not like the idea of trading iron condors, do not believe that switching to the double diagonal will solve your problems.

Full screen video (recommended)

More on DD

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