Bearish Diagonal V Bear Call Spread

P

Pinozi

Hi Option Punters

I've been doing some modelling using options oracle and have been doing some work with diagonals. I just wanted to hear peoples experience with these tricky spreads

Here is an example on the SPX

SPX @ 880

I am bearish the market so I would like to sell an OTM bear call spread

Sell Jan 910 Call @ 30.6
Buy Jan 930 Call @ 22.35

Credit $825
Margin $2000

Breakeven Point 918.25


But what about this bearish diagonal

Sell Jan 870 Call @ 51.5
Buy Feb 920 Call @ 47.45

Credit $405
Margin $5000

Breakeven Point 929.19


Now obviously Im comparing two very different strategies, but both are trying to achieve a similar result

From my observations the risk reward seems better on the credit spread but you have a chance of making more than just the credit on the diagonal. Also the diagonal is long vega so if the market drops suddenly then you have a chance to get out early with a decent profit. Obviously if your view is that IV will fall then the credit spread works better.

I would like to hear some real world experience with these spreads such are they hard to get filled on entry or exit and if they perform differently than expected once placed.

Also are there some advantages/disadvantages I am missing in my example above - as it seems the diagonal looks like a possible alternative to a credit spread should you want a long IV outlook

Cheers

pinozi
 
If the underlying finishes the January cycle at ATM of the January option, you will make more than your initial credit. If the underlying moves swiftly downward, you can lose more than the initial credit. Swift, downward movement will cause the FEB call to lose value faster than the January call. Upward movement will allow the FEB call to gain a little faster than the JAN call. Either way, swift movements are not desired. It's all about vega, gamma and theta.
 
Quote from Pinozi:


Sell Jan 910 Call @ 30.6
Buy Jan 930 Call @ 22.35

Credit $825
Margin $2000

But what about this bearish diagonal

Sell Jan 870 Call @ 51.5
Buy Feb 920 Call @ 47.45

Credit $405
Margin $5000


pinozi
More...

I know you are bearish, but if you are wrong you are going to be PUNISHED with the diagonal.

If the market heads higher, IV will head lower. This spread is long vega, so that's one strike against you.

If the market rallies strongly, the maximum loss on the diagonal is obviously much large than the maximum loss on the bear call spread.


Thus these questions:

Do you want to take all this extra risk?

Do you anticipate that there will be sufficient extra profit potential to justify that risk?

If the market does head lower, how disappointed will you be to earn 'only' the credit from the bear spread?

There is no 'right' answer. It's a personal decision based on your comfort zone and your confidence that the market is headed lower.

I would choose the bear call spread.

Mark
http://blog.mdwoptions.com/options_for_rookies/
 
Thanks for the reply Mark

The example shown was just theoretical and I just wanted to get a discussion going

The way I see it there seems to be a lot of people who trade iron condors. This strategy is similar to the double calendar or double diagonal in that you want the market to stay within your breakeven points.

Ive seen people who only do condor trades or leg into iron condors and wanted to see if anyone would use diagonals in a similar fashion e.g. place a bearish diagonal when you see a market top then place a bullish diagonal when you see a market bottom giving you a double diagonal
 
Quote from Pinozi:

Ive seen people who only do condor trades or leg into iron condors and wanted to see if anyone would use diagonals in a similar fashion e.g. place a bearish diagonal when you see a market top then place a bullish diagonal when you see a market bottom giving you a double diagonal
More...

Speaking for myself and my trading style, I buy iron condors frequently.

I choose double diagonals instead - only when I feel IV is 'low.'

Because the difference between the strike prices tends to be wider with a diagonal than a vertical spread [more on this below] the risk of an upside market move is greater. Not only do you have delta and gamma risk, but vega can hurt when you own the outer month and watch the IV get crushed.

That's why I must be a believer that IV is heading higher - or at east not lower - before trading those diagonals.

Most diagonal traders feel the NEED to open the trade for a cash credit. Thus, they make the strikes far enough apart to obtain that credit. That's a mistake IMHO. My style is NOT to pay a large debit, but I'd rather have the strikes nearer to each other and am willing to pay a small debit to accomplish that. Don't misunderstand - I prefer a credit also, but do not insist on it.

The higher the current IV, the more the outer month options cost. That's another reason to avoid the play. You already have upside risk. The question is: Are you willing to make it worse? It's a personal decision.

Mark
 
Quote from Pinozi:

Hi Option Punters

I've been doing some modelling using options oracle and have been doing some work with diagonals. I just wanted to hear peoples experience with these tricky spreads

Here is an example on the SPX

SPX @ 880

I am bearish the market so I would like to sell an OTM bear call spread

Sell Jan 910 Call @ 30.6
Buy Jan 930 Call @ 22.35

Credit $825
Margin $2000

Breakeven Point 918.25


But what about this bearish diagonal

Sell Jan 870 Call @ 51.5
Buy Feb 920 Call @ 47.45

Credit $405
Margin $5000

Breakeven Point 929.19


Now obviously Im comparing two very different strategies, but both are trying to achieve a similar result

From my observations the risk reward seems better on the credit spread but you have a chance of making more than just the credit on the diagonal. Also the diagonal is long vega so if the market drops suddenly then you have a chance to get out early with a decent profit. Obviously if your view is that IV will fall then the credit spread works better.

I would like to hear some real world experience with these spreads such are they hard to get filled on entry or exit and if they perform differently than expected once placed.

Also are there some advantages/disadvantages I am missing in my example above - as it seems the diagonal looks like a possible alternative to a credit spread should you want a long IV outlook

Cheers

pinozi
More...

Good thing you didn't make that bet. It looks like it was a losing trade until today. The VIX dropped 9 points from the 19th to the 2nd. Combine the lower IV with the SPX peaking at 943 yesterday, you probably would have cried uncle yesterday (or earlier) and closed the trade.

I see where you're going with the question, though. You want vega and delta to work together for a quick trade. If things go well, you could get out with a nice profit in 7-10 days. The problem is, if they can both work for you, they can both work against you too, hence the extra risk.

Quote from Pinozi:



Ive seen people who only do condor trades or leg into iron condors and wanted to see if anyone would use diagonals in a similar fashion e.g. place a bearish diagonal when you see a market top then place a bullish diagonal when you see a market bottom giving you a double diagonal
More...

I think you would just close one trade and open another if you were right about the bottom and then were right about the top.
 
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