Lets say I think XYZ will rise in the near future but I am not sure it will happen too fast. XYZ is traded at 100, I open a calendar spread by buying week 2 110 call for 2$, and selling week 1 110 call for 1$. I have a net debit of 1$. Now I understand that the best thing for me is that at expiration XYZ will trade exactly at 110 which is great and all but! If suddenly XYZ discovered how to cure cancer and now it is traded at 130, now it means I have to buy back the short call resulting in a major loss, I do have the long call so I can sell it too but since I've entered that trade for a debit of 1$ I think I will incur in such circumstances the max loss which is the debit I've paid of 1$. How shall I enter a calendar spread that won't loss when my direction was right? is that possible? is that only possible with diagonal spreads? if so how? Thanks in advance
You can't avoid that loss on a gap up...You would get killed in a diagonal since you have an embedded short vertical in there. There is no adjustment there other than eat your $1 debit. If it "meanders" up, depending on the time till open trade date, you can take $$ off the table and reposition your calendar to a higher strike. There will also be loss as the implied vols sink which they often do on up moves (on equities in general). Depending on the IV regime, you might want to consider broken wing flies 1:3:2 or 2:3:1 again depending on prob distro..BUT issue w flies is that you can't harvest your $$ till the end... Check out my site for a case study of that... edgequestllc.com..if u are that bullish just a vertical perhaps?
oh yes that would work I meant diagonal on the opposite end.. ie 115 on the w2 strike... Here you are embedding a long vertical. but this is a higher debit which you will eat if xyz goes down .. plus you are longer vega so if XYZ moves up, you'd get dinged a little due to up move....
Ofcourse you wouldn't buy the w2 call @ 115. This will make a bear call diag spread. OP was after a position that will profit if underlying increases.
bear call diagonal spread work all the time on bullish moves too.. very well in fact.. unless it rips .. here is a 106/107 diag if XYZ goes up to 107 slowly,, you can harvest some $$$ and roll up.. if you are wrong you lose very very little. Big problem if 108 next day on a gap up.
Bear call diagonal spread in your example is bullish only because of the Calendar spread component of it. Not the Call spread component. To return to OP's original inquiry, if you want to make no losses if the underlying gaps up, you would need to have a bull call diagonal spread.
hey Sakti. If you look at my post I did not dispute your assertion that on a bull move your spread is inferior.,, in fact that is a better do. ... all I am saying is that a bear diagonal will work on bull moves as well under certain iv regimes under certain price action.... and yes i kinda have an idea where the $$ is coming from... been trading these things for > 20 years.. Lastly if he is really that worried about being too right he can use a backspread. but it comes with it's own set of "gotchas"