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April 10, 2014

Double Your Pleasure

With earnings season just kicking off once again, it might be a good time to talk about a subject that is brought up quite often in MTM Group Coaching and Online Education and is often debated by option traders learning to trade advanced strategies; double calendars vs. double diagonals.

Double Calendars vs. Double Diagonals
Both double calendars and double diagonals have the same fundamental structure; each is short option contracts in nearby expirations and long option contracts in farther out expirations in equal numbers. As implied by the name, this complex spread is comprised of two different spreads. These time spreads (aka known as horizontal spreads and calendar spreads) occur at two different strike prices. Each of the two individual spreads, in both the double calendar and the double diagonal, is constructed entirely of puts or calls. But the either position can be constructed of puts, calls, or both puts and calls. The structure for each of both double calendars or double diagonals thus consists of four different, two long and two short, options. These spreads are commonly traded as “long double calendars” and “long double diagonals” in which the long-term options in the spread (those with greater value) are purchased, and the short-term ones are sold. The profit engine that drives both the long double calendar and the long double diagonal is the differential decay of extrinsic (time) premium between shorter dated and longer dated options. The main difference between double calendars and double diagonals is the placement of the long strikes. In the case of double calendars, the strikes of the short and long contracts are identical. In a double diagonal, the strikes of the long contracts are placed farther out-of-the-money) OTM than the short strikes.

Why should an option trader complicate his or her life with these two similar structures? The reason traders implement double calendars and double diagonals is the position response to changes in IV; in optionspeak, the vega of the position. Both trades are vega positive, theta positive, and delta neutral—presuming the price of the underlying lies between the two middle strike prices—over the range of profitability. However, the double calendar positions, because of placement of the long strikes closer to ATM responds favorably more rapidly to increases in IV while the double diagonal responds more slowly. Conversely, decreases in IV of the long positions impacts negatively double calendars more strongly than it does double diagonals.

In future writings, the selection of strike prices and position management based on the volatility of the stock will be discussed. In addition, other option strategies will be introduced and guidelines will be discussed to help the trader select among these similar strategies when considering trades and alternatives.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

June 16, 2011

All In The Family

Filed under: Options Education — Tags: , , — Dan Passarelli @ 9:29 am

For the new options trader one of the most overwhelming concepts is the wide variety of choices of trade structures available in the new world into which he has entered. The world of stock trading is defined by only two initial choices when considering a trade: short or long. The world of options has many more choices when initiating a trade and each option trade is most profitably defined not only in terms of price but also implied volatility and time.While description of each and every type of option trade is well beyond the scope of a brief discussion such as this, it is helpful to focus on the various families of option trades in order to begin to become familiar with the unique characteristics of each member. One of the most frequently discussed types of trades can be described as those that are profitable over a wide range of prices of the underlying. This group of trades finds its basic family identity in the shape of the P/L curve as well as in the signature family blood type of theta positive.As in any diverse family, there is a wide variety of individual characteristics. The names of the individual strategies within this family is numerous, often duplicative, and frequently confusing. One subgroup of these range bound strategies is flamboyantly named as winged beasts: condor, iron condor, butterfly, iron butterfly, and split strike butterfly. Another less colorfully named branch of the family is that of the double calendar and double diagonal. The structure of each of these trades has a characteristic skeletal framework, but within these defining limits, the latitude in fine structural details is broad.