Diagonal Call Spread
This strategy
involves buying long term calls and simultaneously writing an equal number of
near-month calls of the same underlying stock with a higher strike.
This
is a good trade to do with LEAPS in combination with short-term options.
Market
Opinion
Bullish
long term, neutral to bullish near term.
P/L
When
To Use
When
you want to generate income on your underlying stock.
Example
XXXX
is trading at $26 on March 20, 2011 (volatility 40%).
Buy
January 2013 25 calls at $6.60.
Sell
April 2011 27.50 calls at $0.55.
Benefit
The
benefit is the ability to accrue monthly income from the underlying stock,
making a greater yield than using a covered call.
Risk
vs. Reward
The
risk is the net debit paid. The reward is the long call value at the expiration
of the short call when stock price is at the higher strike price minus net
debit.
Net
Upside
The
stock price is at the higher sold call strike price at expiration.
Net
Downside
The
net debit of the calls purchased less the sold calls.
Break
Even Point
The
lower strike price plus net debit paid.
Effect
Of Volatility
N/A
Effect
Of Time Decay
Positive
to income by eroding the value of the short call faster. Negative by eroding
the value of the long call.
Alternatives
Before Expiration
If
the position falls to 60% of the purchase price, close the position.
Alternatives
After Expiration
If
stock price higher than strike price of the sold call, you can either
1)exercise your call to cover your sold option being called and take the
profit, or, 2)roll over to the next month by buying back the call and selling
the next month’s call at the same or higher strike price.
