Owning a Call for "Free"

MarkBrown · May 14, 2025 at 4:46 PM

Sekiyo said:
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.
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what level of voodoo is this?

zdreg · May 14, 2025 at 4:50 PM

MarkBrown said:

what level of voodoo is this?
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ET response voodo.

SimpleMeLike · May 14, 2025 at 5:17 PM

Sekiyo said:
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.
More...

Hello Sekiyo,

Day Trading is Easy. SimpleMeLike

SimpleMeLike · May 14, 2025 at 5:34 PM

Sekiyo said:
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.
More...

Hello Sekiyo,

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Owning a Call for "Free"

MarkBrown

zdreg

SimpleMeLike

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