The Double Diagonal is a neutral option trading strategy with a good chance of a relatively small gain.
Option Trading Subjects:
Strategy: Double Diagonal
The Outlook: Mostly neutral. Not expecting dramatic movement up or down before the expiration of the options. Entering when volatility is low is preferable.
The Trade: For the trade graphed above, sell puts one strike below current stock price using a near expiration, buy puts one strike below that and using the next expiration month. Sell calls one strike above current stock price using a near expiration, buy calls one strike above that and using the next expiration month.
Gains when: Stock stays in a reasonably narrow range near the current stock price.
Maximum Gain: Because of the different expiration months, you must use an options calculator or graphing software to calculate the maximum gain.
Loses when: Stock moves beyond one of the breakeven points.
Maximum Loss : Limited, but must use options calculator or graphing software to calculate. Always more than the maximum potential gain.
Breakeven Calculation: Because of different expiration months, must use an options calculator or graphing software to calculate the breakeven.
Advantages compared to stock: Increased leverage, much less capital required, "built-in" stop loss, can gain from no stock movement or limited stock movement, can gain from a rise in implied volatility.
Disadvantages compared to stock: Will lose if stock rises or falls beyond the breakeven points, no dividends.
Volatility: after entry, increasing implied volatility is positive.
Time: after entry, the passage of time is positive.
Margin Requirement : Some brokers will require margin as if you have two credit spreads. In the example, the margin would be $1000. More sophisticated brokers may allow margin of half that, in recognition of the fact that the strategy can only lose on one side.
Variations: Use all calls or all puts. The call or put variations are entered for a debit. You can also target stock prices higher or lower than the current price, as shown at the end of this page.
The graph below shows what happens if you try to set up a Double Diagonal with the short strikes too far apart, in order to increase the range of profitability. The graph sags in the middle, eliminating gains instead of increasing your chances of a gain. Plus, commission costs could easily overcome any chance of profitability at most stock prices.
If your opinion on a stock is not strictly neutral, but more like "neutral to bullish", you can set up the Double Diagonal to take advantage of that by using short strikes closer together, and in a more bullish relationship, as shown on the graph below. You can do the same thing using more bearish strikes if your opinion is "neutral to bearish".