What are the characteristics of this option strategy?
Double diagonal spreads combine a call diagonal and a put diagonal into a single neutral position, so the trade involves the purchase and sale of four options across different strike prices and different expiration dates. The purpose is to collect the faster time decay of the near-dated short options while the further-dated long options sitting outside them contain the risk. The trade therefore pays off when the underlying stays inside the short strikes through the near-term expiration, not when it moves sharply.
Is this a bullish, bearish or neutral strategy?
The Double Diagonal Option Strategy is a neutral strategy because it profits when the underlying stays between the short strikes through the near-term expiration, letting the short options decay faster than the longer-dated long options. It is, however, possible to use the strategy in a bullish or bearish manner.
Is this a beginner or an advanced option strategy?
The Double Diagonal Option Strategy is generally considered to be an advanced option strategy, as it involves the purchase and sale of multiple options and is best executed with a good understanding of market volatility and the Greeks.
In what situation will I use this strategy?
The Double Diagonal Option Strategy is usually used when the underlying is expected to stay range-bound through the front-month expiration. A sharp price move in either direction is the loss case; calm, range-bound markets are what the strategy is built for.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
The Double Diagonal Option Strategy offers a modest reward with a reasonably high probability of profit, because the profitable zone between the two short strikes is wide. The loss is limited rather than open ended, since each short option is covered by a longer-dated long option a few strikes further out. The exact worst case is not knowable in advance, though: what the longer-dated options are worth at the near-term expiration depends on where implied volatility is at that moment. A rough ceiling on the loss is the strike width on the tested side, less the credit received if the package was opened for a credit or plus the debit paid if it was opened for a debit. Check which one you have before you size the trade: because the long options carry more time than the short ones, and further out of the money puts usually carry higher implied volatility, a double diagonal is frequently opened for a small net debit rather than a credit, and in that case the worst case is wider than the strike gap, not narrower.
How is this strategy affected by the greeks?
This strategy is heavily affected by the greeks, as the multiple options involved result in significant exposure to the greeks. The main greeks that affect this strategy are Delta, Gamma, Theta, and Vega.
In what volatility regime (i.e VIX level) would this strategy be optimal?
The position is net long vega, because the long options have more time to expiration than the short ones. It therefore gains value if implied volatility rises after entry and loses value if volatility falls. That makes a low or middling VIX the better entry point, with the trade positioned for volatility to come back up, which is the opposite of what a plain credit spread wants. Opening a double diagonal straight after a volatility spike means paying up for the long options and being hurt when volatility drifts back down.
How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?
Adjusting this strategy when the trade goes against you can be difficult, as the multiple options involved require careful attention. If possible, the optimal solution is to close out the losing position. If it is necessary to adjust the trade, the adjustments need to be carefully calculated to ensure that the risk remains consistent with the original strategy.
Where does this strategy typically fall in the range of commissions and fees?
The Double Diagonal Option Strategy typically falls in the range of medium to high commissions and fees. This is due to the multiple option trades involved and the complexity of the strategy.
Is this a good option income strategy?
The Double Diagonal Option Strategy is a time-decay strategy, so it is closer to an income trade than to a speculative one. The income comes from the near-dated short options expiring worthless while the longer-dated long options retain value, and the structure can be repeated by selling a fresh pair of short options after each front expiration. The profits are modest and capped, however, and a single sharp move through one of the short strikes can hand back several cycles of collected premium.
How do I know when to exit this strategy?
Exiting this strategy depends on the trader’s risk tolerance level and overall market conditions. The general rule is to exit when the profits are no longer sufficient to justify the risk of the trade.
How will market makers respond to this trade being opened?
Market makers will usually respond to this trade by adjusting option premiums and gamma levels. This is due to the complexity of the strategy and the relatively higher levels of risk involved.
What is an example (with calculations) of this strategy?
A basic example of the Double Diagonal Option Strategy would be as follows. With MSFT trading at $265, the investor sells a near-dated $280 call expiring in about 30 days and buys a later-dated $285 call expiring in about 60 days, then sells a near-dated $250 put and buys a later-dated $245 put. The two short options sit inside the two long options and decay faster than they do. Suppose the package is opened for a net credit of $1.90 per share, or $190 for a one-contract structure. That is an assumption, not a given: the long options have twice the time to expiration, so the same four strikes can just as easily price as a net debit, and the numbers below have to be redone with the opposite sign when they do.
The winning outcome is a quiet stock. If MSFT is anywhere between $250 and $280 when the near-dated options expire, both shorts expire worthless, the investor keeps the $190, and the $285 call and $245 put still carry time value that can be sold or used to cover the next pair of short options. A sharp move is the losing outcome. If MSFT jumps to $300, the short $280 call is $20 in the money while the long $285 call carries $15 of intrinsic value plus whatever time value remains, so the loss is contained by the $5 gap between the two call strikes less the $190 credit, roughly $310 before crediting the long call's remaining time value. The same arithmetic applies on the put side if MSFT falls through $250. That is the trade off in one line: a narrow credit for the range, and a loss several times that credit if the stock leaves it.
MarketXLS.
MarketXLS is a powerful stock analysis tool that can help you take advantage of the Double Diagonal Option Strategy. It allows investors to quickly analyze options and calculate the risk-reward and probability of the strategy. It also allows investors to quickly perform sophisticated adjustments when the trade goes against them. By placing their trades directly from MarketXLS, investors can save time and see what the Double Diagonal Option Strategy stands to make and what it stands to lose before they place it.
Here are some templates that you can use to create your own models
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Relevant blogs that you can read to learn more about the topic
Double Diagonal Option Strategy
Double Diagonal Option Strategy
Leverage Vega to Maximize Your Option Gains