From Options as a Strategic Investment. Do you have any feedbacks on diagonal spreads ? Do you know any other way to get free, convex, trades ? Owning a Call for "Free" – Diagonalization in Spread Strategies Diagonalization can be used in other spread strategies to accomplish much the same purposes already described. But in addition, it may also be possible for the spreader to wind up owning a long call at a substantially reduced cost, possibly even for free. The easiest way to see this would be to consider a diagonal bear spread. Example: Stock: XYZ Current Price: 32 April 30 Call: Selling for 3 points July 35 Call: Selling for 1.50 points A diagonal bear spread could be established by selling the April 30 call and buying the July 35 call. This is still a bear spread because a call with a lower strike is being sold while a call with a higher strike is being purchased. However, since the purchased call has a longer maturity date than the written call, the spread is diagonalized. Profit Potential This diagonal bear spread will make money if XYZ falls in price before the near-term April call expires. For example: If XYZ is at 29 at April expiration: The April 30 call expires worthless The July 35 call still has some value, perhaps 0.50 Profit = 3 (April 30) - 1 (loss on July 35) = 2 points Risk Considerations The risk in this position lies to the upside, just like a regular bear spread. If XYZ rises substantially (e.g., both calls at parity at 35+): The spread widens to 5 points Initial credit was 1.50 points Loss = 5 - 1.50 = 3.50 points Diagonal spreads will do slightly better to the downside (long call retains some value) but worse to the upside (larger loss if stock rallies). Why Use This Strategy? The primary reason a strategist might attempt a diagonal bear spread isn't for the slight downside advantage. It's because there’s a chance to own the long-term call for free. In this example: Cost of July 35 call = 1.50 Premium received from April 30 call = 3 If a profit of 1.50 or more is realized on the April 30 call, the cost of the July 35 is fully covered. Follow-up Example: If XYZ is at or below 31.50 at April expiration: The April 30 call can be bought back for 1.50 or less Since it was sold for 3, the profit is at least 1.50 This covers the entire cost of the July 35 call At this point, the strategist effectively owns the July 35 call for free. If XYZ never rallies above 35 → No further profit If XYZ rallies above 35 before July expiration → Unlimited upside Conclusion Whenever a diagonal spread is established for a credit, there’s always the potential to own a long call for free. That is, the profit from the short-term option could offset the cost of the long-term call. This creates a very desirable position: if the stock rallies after the short side profits have been taken, large gains could be achieved with no additional cost.
In calls as a credit it's a bear spread as your initial deltas are certainly going to be negative. If grandma had balls she'd be grandpa. Yeah, if it drops iinside the M1-strike it's free. Fantastic. But most are going to take whatever debit is in M2 when M1 goes off. If you're holding M2 post M1 exp then you're not large enough for it to matter. IOW you're not simply after the credit but in most cases that's what you're getting, or some trivial multiple of that initial cr. There is no edge in this structure and his free call can end up as a pseudo backspread and hurt you if vols roll over or you flip delta position. It's analogous to a silly up and out KO call where you need it to close just inside the M1 strike. Same goes for Cottle. Silly sht that is bog-obvious.
Be careful with these "amazing" recipes. Look for the impact of changes in volatility in calendar spreads, and you will see that not everything is as amazing as it looks.
Yes, I didn't play with it (yet) and I am a newb therefore I had no a priori before your inputs. Thanks.
There is some skew edge in upside index as the skew trades inverse to moneyness, but we're talking pennines in index and your gamma and vol corr will eat up that edge when you're wrong.
I prefer narrow diagonals into the left tail even though you're paying a small skew prem. Vega/skew >1 (hit to initial cr) but you're being paid on synthetic vol (VAST). Your vega starts to get meaningful as time passes and vega will be massive into your delta/gamma risk (which is what you inevitably want) to earn on all exposures as you approach exp. It's a good bear spread when you go lightly net long cars into M2. IOW, you get shorter dela and longer vol as time approaches. Mkt trades away but you paid nothing for it and you may gain a bit from skew. SPX 5700/5725 ps as approaches M1 exp. Win on vol corr and vega as we drop. Skew not a factor other than trivial impact to initial cr. The problem is that you will get obliterated if SPX trades through the strikes so always have some net puts in M2.
The 'free call" is piker stuff. The idea is to own a lot of vol for little to no outlay. It's inherently a hedge against the vol-line you're paying, right? Because you don't have any debit or vol-risk away from the strikes. Otherwise you'd be in a calendar and trade it to a strike touch (upside it's vol corr vs. delta gains), but then you're much more sensitive to vol but less so to gamma (as with the diag). IOW, what do you care if you're long 25-line in SPX if it's a credit? You have modality risk, etc., but you know that going in.
Woulda Shoulda Coulda...sounds complex and sloppy trying to guesstimate the future only to break even on your stagnant stale time of averages I personally prefer understanding and timing on a daily scale time frame. Refinement and precision