Double Diagonals

Hi Mark,


I was going through your double diagonals and was not able to glean guidelines as to how to open and manage the trade.

For example, when (how many days out from your long/short strike expiration) do you put on the diagonal, how do you choose the short strike in the near month (your own criteria, if you will please!) and I read somewhere in your blog that you cover them when the delta of your long exceeds the delta of your short (making it more vulnerable to price moves against that leg).

Also when you do take off one leg of the diagonal do you roll up the other leg (since it is very likely that it is now quite far away from the current price).
Thanks

Rajesh

***

Hello Rajesh,

You are asking for a whole lesson on how to trade a specific strategy, and that is an entire book chapter in itself.

Double diagonals (DD) are managed similarly to iron condors (IC), but there are enough differences to warrant additional discussion.

First, take a look at these posts that I wrote for InvestorPlace, formerly known as the OptionsZone.  They provide an introduction.

Investor_place_logo

Part I

Part II

Part III


Next, review Chapter 21, if you own The Rookies Guide to Options.

Then look through the previous posts on double diagonals.

Come back with specific questions.

***

My criteria are not likely to prove helpful to you because I seldom use this strategy.  I only use DD under one condition:  To adjust the vega risk of my portfolio:

a) When my portfolio is short too much vega [That means I have too much risk if implied volatility moves higher.  Of course, I'd profit if IV moves lower], I add some double diagonal spreads.

b) When I believe implied volatility is 'low' enough so that I don't want to be short any vega, then I reduce my portfolio to vega neutral by trading both iron condors an double diagonals. 

c) When I believe that implied volatility is so low that I want to bet that it will increase soon, I'll trade double diagonals almost exclusively.

I consider this strategy to be very similar to iron condors (it is an iron condor with an embedded calendar spread), and usually prefer to trade the simpler to manage iron condor.

If you want guidelines for entering positions, I suggest picking (not trading, just mentally selecting) the calendar spreads you want to own and then trade the double diagonal accordingly.

My preference is to open the double diagonal when the shorter-term option is about two months from expiration and the other is one additional month. 

791




5 Responses to Double Diagonals

  1. semuren 09/20/2010 at 4:19 AM #

    The main adjustment that I have seen for double diagonals (a type of spread I do not trade much) is to buy the opposite diagonal from the threatened one you have on and thereby turn the threatened side into a double calender. On the positive side this moves the expiration BEP out. On the negative side it costs a good bit of cash (and you should, and may need, to plan to have that cash around BEFORE you put on the original position); and, it puts you into a double calendar that might not be the trade you want. Assuming you look only at raw vega (if you look at weighted vega I think it is an empirical issue that you would need to look at on a case by case basis, but maybe that just shows you how little I really understand weighted vega) on the up side you are getting long more vega when you are adjusting to offset a fear that price may keep moving up. In equities and equity based indexes volatility usually going to go down as price moves up, so you can see why this might not be ideal. The converse is true on the put side.
    A related suggestion: for expiring monthly could you have a point counter point on weighted vega and how to (or why not to) trade calendar (and calendarized spreads).

  2. Mark Wolfinger 09/20/2010 at 9:25 AM #

    Hi semuren,
    I don’t like the double calendar fix. I’d rather exit. After all, not every trade is worth saving because the ‘fix’ can increase risk.
    However, your ‘weighted vega’ idea is important. I admit that it’s something to which I have paid insufficient attention. I have been working with the simple assumption that vega is vega.
    I found an excellent description of weighted vega by my Expiring Monthly partner, Mark Sebastian. Take a look.

  3. Rajesh 09/21/2010 at 4:50 AM #

    Hi Mark,
    Some specific questions: if the spread benefits from the price coming close to the strike of the short option and gets hurt by the price shooting across it, why not wait for the price to go through the short strike by a small amount and then close down part of the position and progressively close down more of the position as it advances further. If we do buy insurance as the price moves towards the short strike and the insuring option (even at a ratio of 1:5) is < the short strike, it is likely to be expensive (due to the delta effect and volatility may or may not contribute to the cost) and can at best mitigate the damage. Of course I am sure you will bring up the fact that the short strike can be breached rapidly and decisively and that always happens when I get into such situations! Also why not open a diagonal in all iron condors (smaller position) on the downside since the volatility will usually increase on the way down. I am also intrigued by your choice of short strike that is two months out. Does it mean that you never hold these to expiration of the short strike (with the exploding gamma risk) and if not what are your profit targets?
    Thanks and sorry for the length of the post.
    Rajesh

  4. Mark Wolfinger 09/21/2010 at 9:06 AM #

    I’m going to post this lengthy reply as a post. As soon as I can get it ready

  5. Rajesh 09/21/2010 at 9:24 AM #

    Thank you Mark for the efforts that you put in and the time that you give to your mission.
    Thanks again,
    Rajesh