Diagonal Time


Yesterday I discussed how time can be spread horizontally, or across the same strike. Today I want to talk about another variation on the time, or calender, spread, the diagonal. This is a trade involving two different strikes.

This spread can be slightly bullish when using calls or slightly bearish using puts. It's also a way of creating free or nearly so, options. Bullish or bearish, a free option is always a good thing to have.

Let's take a real life example of a diagonal trade with a slightly bullish bias. Let's say you think Apple (AAPL) will drift along for now and then move higher. With AAPL at 528.50 you can sell the March 550 call at 3.50 and buy the April 580 call at 2.70, for a .80 credit. If AAPL is below 550 at the March expiration you own the April 580 call for less than free!

Of course, if AAPL is above 550 in March you'll want to unwind the position because you don't want that short call to turn into short stock.

Let's say, though, that you think this rally will continue for just awhile longer and then the market will turn lower a put diagonal is a good trade. Take the S&P 500 ETF (SPY). With SPY at 184.60 you can sell the March 180 put at 1.15 and buy the April 175 put at 1.25. If the March put expires worthless than you have the April put for just .10.

A diagonal time spread is a bit riskier and more directional than a horizontal time spread (see yesterday's column) but the payoff is potentially greater.

By: Randall Liss, The Liss Report