More on Double Diagonal Spreads

Fresh update to SPY Double Diagonal trade.



Questions/comments from Wayne demonstrate how complex it can be to justify adopting a specific strategy for a trade, or even making the trade itself. I believe we are all familiar with the simple credit spread (or iron condor). There are a bunch of things that must be decided for each trade. We must choose a strategy, position size, construct a trade plan (which itself involves several decisions). We have to select an underlying asset. It’s a good-sized list. Fortunately we do not have to make every decision every time that we trade. Some of the decisions are already implanted in our minds – based on what has been happening in the stock market.

Specifically related to double diagonals:

Mark,
Ok now that I finished watching this very valuable video, I still have a question–one raised before but now having watched the video, I have a different perspective: Why have the DD and not just a calendar? In this video, you explained that the DD is really equivalent to an iron condor + two calendar spreads. Therefore, one should not put on a DD if he/she does not like the embedded IC. So, to answer my question “why have the DD and not just a calendar”, is it because with the DD we get all the characteristics of an iron condor–positive theta, negative vega and this is important because it helps neutralize the positive vega of the calendar? Perhaps, the second point i.e. positive vega getting neutralized/ reduced due to the characteristic of the embedded IC, is especially important?
In other word, to say it simply: we like all the characteristics of the iron condor, and we get it here in the DD but not the calendar spread alone.
Is that the right thinking?
Wayne

Listened to the video more thoroughly again, then let me ask about putting on the calendar only. Doing so is really fine if I already have an existing iron condor, and the calendar is to hedge the loss arising from an adverse market move threatening that IC What about that thinking? Yes. The calendar is a suitable adjustment to an iron condor.

And in that scenario, I would put on a calendar with the short strike closer to the money than that of the iron condor. In that way, I achieve my max profit near those “peaks” as shown on your risk graph for the calendar–i.e. approaching the short strike but not over–but before it hurts the short of the iron condor.

But then as I am writing this description here, I can see that takes a great deal of very accurate market timing to do what I propose–also considering the fact that the area of profitability widens as time passes, which means it’s really difficult to exactly pinpoint the area of max profit.
I don’t know if I make any sense!

The first important thing I must mention is that the double diagonal is seldom going to be a strategy of choice. The conditions that suggest trading the double diagonal do not appear that often. Thus, we cannot anticipate using it frequently. This is NOT the same as choosing a covered call or a put credit spread or an iron condor. It is different. It requires some need on the part of the trader to buy vega.

Wayne raises the important, but troubling for me, question: Why not just trade the calendar spread? That would offer lots of positive vega.

1) The calendar spread is often expensive. The embedded iron condor reduces the cost.

2) the calendar spread is a directional play, and the trader may not want to make a directional bet. True, we can buy (the most expensive) calendar spread by choosing a strike price that is ATM, but if the market drifts away from that strike, money can be lost.

If we own an iron condor and the market drifts away from the position midpoint, that’s not a problem. Thus, the calendars would often lose when the iron condor would be profitable.

3) If we don’t like the embedded IC, there must be a reason. If that reason is the likelihood of a decent market move, then owning calendar can be a winning bet. However, the there no money to be made by owning OTM calendar spreads unless the trader buys the correct spread: calls or puts. If we buy both, the likely result is to earn one profit and one loss – if we are correct in pour market prognostication. If the market goes nowhere, you lose on the calendar(s) when the IC would have been profitable.

4) Sometimes the market will move towards the strike of the calendar, offering an opportunity for a good profit.

However, the big profit comes when IV increases and the underlying moves towards the strike. This trade remains a play on rising IV, but it’s also a directional play. If the trader does not want to make these bets then the calendar is not a good choice.

Wayne,

I don’t believe that you should be looking for reasons why a specific strategy should be used. I believe – and this may be a subtle difference – that you should be aware of several strategies so that you can find one, or a combination, to use at any given time.

I have not paid much attention to the calendar spread as a stand alone trade. But that is a personal bias of mine. I prefer other methods.

    1. If market neutral, I prefer the iron condor which has less vega risk.
    2. With a bullish bias, I prefer to sell OTM put spreads, rather than buy OTM call calendars. You may feel differently. That’s fine.

Yes, I will use the calendar as a position adjustment, but not as a stand-alone play. The latter requires estimating where the underlying asset is headed, and I prefer never to make such guesses.

Yes, your thoughts makes sense. Remember that you will never see that ‘maximum profit’ for the calendar, unless you hold all the way to the end. With even one or two days to go, the calendar trades with a high premium and has a ton of negative gamma. You must also remember that if the market moves through the calendar strike, you will begin to lose money on both the calendar and your remaining short credit spread.

Moral of the story

There is no best strategy.

You must choose a strategy that provides profits – when your expectations come true.

If you have no expectations, your strategy choices are fewer. Bulls, bear, and neutrals – each have choices. Do not fall in love with only one method – until and unless you have examined the alternatives and truly believe your personally chosen strategy is good under most market conditions.

Thanks for the comments/questions

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