Managing Double Diagonal Spreads | Adjustment Methods | Calendar Spreads

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In the previous video titled “Double diagonal spread as an income strategy” there were some typos in the first slide so I am redoing it. Also, in this video we will be learning four methods on how to manage the double diagonal spread, along with some considerations.

Difference between calendar spreads and diagonal spreads:

Calendar spreads consist of two options of the same type (call/put) and same strike price, but have different expirations, while diagonal spreads consist of options that have different strike prices as well as different expiration dates.

Double calendars and double diagonals differ only in the placement of the long strikes. In double calendars, the short and long contracts are placed at the same strike prices, whereas in double diagonals, the long contracts are placed farther out of the money than the short strikes.

Management:

Say, two days into the trade, Nifty moved up to 10500 close to the short strike of 10600 on the call side.

First Method: Roll up the short option

Buy to close the 11 June 10600 strike price call at the current market price and sell to open the 11 June 11000 strike price call at the current market price thereby turning the call side into a Calendar spread with calls.

Risk Graph: This adjustment would reduce the risk on the tested side but would add some risk to the untested side but the amount of profit that could be made would go up.

Second Method: Roll out the short option

Buy to close the 11 June 10600 strike price call at the current market price and sell to open the 18 June 10600 strike price call at the current market price.

Sometimes you may also have to roll out and up the short option depending on how bullish the underlying asset is. The adjustment might look something like this - Buy to close the 11 June 10600 strike price call at the current market price and sell to open the 18 June 10800 strike price call at the current market price.

Risk Graph: This adjustment would reduce the risk on the tested side without increasing the risk on the untested side but the amount of profit that could be made would come down as you might be taking a loss on the closed short position.

Third Method: Convert the diagonal call spread to double calendar spread with calls

Sell to open the 30 July 10600 strike price call at the current market price and buy to open the 11 July 11000 strike price call at the current market price. This adjustment creates a double calendar spread with calls - one call calendar spread at the strike price 10600 and the other at 11000.

Risk graph: This adjustment would reduce the risk on the tested side but would increase the risk on the untested side.


Fourth Method: Add another diagonal call spread to the call side

Sell to open the 11 July 10800 strike price call at the current market price and buy to open the 30 July 11200 strike price call at the current market price. This adjustment adds a new diagonal call spread (10800/11200) to the already existing diagonal call spread (10600/11000).

Risk Graph: Though this adjustment would push the break even point farther away, it would increase risk on the tested side should the underlying move beyond the break even point.

Considerations:

The risk graphs presented here might differ from the risk graphs when you actually make an adjustment depending on the option prices at that specific time. They have been presented just to give you an idea of what to expect with each adjustment.

Also only call side adjustments have been presented. You might want to modify the adjustments to initiate them on the put side as well, if required.

A double diagonal spread should be initiated only in low IV environments (preferably when India Vix is below 30 levels) as though an increase in volatility has a positive effect, any decrease in volatility is negative for the strategy.