The market has moved much higher since the (hypothetical) diagonal back spread was opened (March 27, 2009). At that time, RUT was trading near 429. Today, when I took a snapshot for analysis, the index is 489.5. That's an advance of more than 14%.
But 33 days have passed and IV has decreased. How has the position performed?
The rally was beneficial, due to positive gamma. But the IV decrease played a negative role also (compare values in column headed: Imp. Vol.).
Most of the time value has disappeared from the May options (460s), and that's good, but the passage of time has hurt our long positions (Jun 500, 510, or 520 calls).
Let's see where the positions stand.
Estimating that we would have to pay $36.90 to buy May 460 calls, the cost to close is: $36,900
When exiting our long calls, we'd be able to collect:
A. Sell 16 Jun 500 calls @$25.40, collect $40,640. Credit for closing the spread: $3,740.
B. Sell 19 Jun 510 calls @$21.00, collect $39,900. Net credit: $3,000
C. Sell 25 Jun 520 calls @ $17.10, collect $42,750. Net credit: $5,850.
All three of these spreads are still profitable.
The current greeks tell us that risk has increased. The position is
One compromise is to sell a small number of long calls, bringing the position nearer to neutral in each of the four greeks listed. That would make the upside less attractive, but this position is risky to hold because a significant decrease in IV is possible, even if it's not likely.
For example, the Jun 520 calls have a 37 delta, and selling 3-lots leaves the position long delta and reduces vega by approximately 200.
The idea behind looking at this trade is to illustrate that owning a small number of extra call options can produce significant profits when the underlying makes a good move. But time decay and a loss due the position's positive vega (the portion of option's premium dependent on implied volatility) can cut into those profits. But if you open a position such as this to provide upside protection for your portfolio – one that has negative gamma (such as an iron condor) then this type of trade can offset some, or all of the iron condor losses.
I'll update this hypothetical trade at least one more time – most likely May 22, using prices from Thursday May 21. That's the last day of trading for the May options.