Questions about setting up diagonals & double diagonals

J

jimmyjazz

I am trying to learn as much as I can about the setup and dynamics of diagonal spreads, either expressed as single directional trades or direction-independent trades (i.e., double diagonals).

Other than pricing issues related to the bid/ask spread, what might influence one's decision to use debit or credit spreads in diagonals, or combinations thereof in a double diagonal?

Thanks for any insight.
 
Options is a TOP-DOWN process.
  1. First you look at the underlying and determine the future trading pattern.
  2. Then you look at the option chain and select the expiry and strikes.
  3. If the bid/ask is acceptable you open the trade.
Your views on the underlying (step #1) will determine the type of trade you open.





:)
 
Thanks, but your answers are wholly unrelated to my questions.

Assume that I have a directional bias on the underlying (or perhaps no directional bias), and that I have selected my short strike(s) using whatever means I deem appropriate. I would like to discuss what factors might go into the decision to use calls or puts for a given spread (bull or bear), with an emphasis on how a trade might be managed as it progresses. Any other insight into diagonals would be welcome.
 
jimmyjazz said:
Assume that I have a directional bias on the underlying (or perhaps no directional bias), and that I have selected my short strike(s) using whatever means I deem appropriate. I would like to discuss what factors might go into the decision to use calls or puts for a given spread (bull or bear), with an emphasis on how a trade might be managed as it progresses. Any other insight into diagonals would be welcome.
More...




IMO ...... micro-managing a trade is counterproductive. You have two choices:

  1. Keep the trade open.
  2. Close the trade at a profit or loss and move on to the next trade.


:)
 
jimmyjazz said:
I am trying to learn as much as I can about the setup and dynamics of diagonal spreads, either expressed as single directional trades or direction-independent trades (i.e., double diagonals).

Other than pricing issues related to the bid/ask spread, what might influence one's decision to use debit or credit spreads in diagonals, or combinations thereof in a double diagonal?

Thanks for any insight.
More...

The biggest thing you need to keep in mind and analyse when playing with cals/diagonals is vega risk. Any type of cal/diag is going to be long vega - so better put on when that particular series vega is towards the lower end and you expect it to expand.

For example you can many times setup a good non-directional and what seems like exceptional risk reward scenarios with say double diagonals when front month vol is pumped up compared to the back (earnings related for example; or some other binary event) - and its not unreasonable to assume that the vol difference will compensate more than what vol crush might happen across the series - but often times the vega collapse takes out a bigger dollar value from the back month than front month.

HTH!
-gariki
 
OptionGuru said:
IMO ...... micro-managing a trade is counterproductive. You have two choices:

  1. Keep the trade open.
  2. Close the trade at a profit or loss and move on to the next trade.
More...

I am more than aware of your stance on the matter. You don't need to keep repeating yourself.

Anyone else?
 
kcgoogler said:
The biggest thing you need to keep in mind and analyse when playing with cals/diagonals is vega risk. Any type of cal/diag is going to be long vega - so better put on when that particular series vega is towards the lower end and you expect it to expand.

For example you can many times setup a good non-directional and what seems like exceptional risk reward scenarios with say double diagonals when front month vol is pumped up compared to the back (earnings related for example; or some other binary event) - and its not unreasonable to assume that the vol difference will compensate more than what vol crush might happen across the series - but often times the vega collapse takes out a bigger dollar value from the back month than front month.
More...

Thank you. This is the type of discussion I was hoping to spark.

I have gotten myself wrapped around the axle on "long vega" trying to imagine why one might want this characteristic in a bear spread. I am conditioned to think of volatility dropping as the underlying rises, so long vega could seemingly make it difficult to get out of a bear diagonal without taking it in the shorts when the underlying moves up. I worked myself into a position where I thought long vega on the bull spread and short vega on the bear spread might be the optimal setup if one is a "defensive" trader, and I don't think that's correct.

Any further thoughts would be greatly appreciated!
 
jimmyjazz said:
I worked myself into a position where I thought long vega on the bull spread and short vega on the bear spread might be the optimal setup if one is a "defensive" trader, and I don't think that's correct.

Any further thoughts would be greatly appreciated!
More...

You are reading it right. Long vega on bull is a killer as even if you are right on direction vega loss might overshadow your directional profits. Short vega on bear spread is good when direction is correct; but will hurt twice as bad on an opposite move - loss due to directional bet as well as vol collapse.

-gariki
 
@atticus once mentioned microstructure as a factor that could gain a few points on occasion. Basically, OTM options are more liquid with tighter spreads... So, if you expect spot to be above your strikes, choose puts, or if below, choose calls. He did this mostly with butterflies and "pitchforks" IIRC, but it may apply to your question about puts vs. calls. The main benefit is to be able to get out of your trade with tighter spreads.
 
kcgoogler said:
You are reading it right. Long vega on bull is a killer as even if you are right on direction vega loss might overshadow your directional profits. Short vega on bear spread is good when direction is correct; but will hurt twice as bad on an opposite move - loss due to directional bet as well as vol collapse.
More...

Sorry, it's been a long day -- is that what you meant to say about short vega & bear spreads?
 
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