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How to trade a Double Diagonal

by Uncle Bob Williams

Description | Graph | Example | Trade Finder Rules
Pricing | Trade Monitor Rules | Conditional Orders

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Double Diagonal Strategy Description:

A Double Diagonal is a hybrid combination of an Iron Condor and a Calendar.

A Diagonal works by Selling an Option on the Strike approximately 1 Standard Deviation away from the current price with the current Expiration Date, and then buying the Next Strike Out on the Next Expiration Date. Think of it like a Condor, except that the Long Position is in the Next Expiration Date.

Same underlying, different Strike, different Expiration dates.

A Diagonal is one side, either the CALL or the PUT. We normally trade both the CALL and PUT together as a Double Diagonal, and that is what the Uncle Bob's Money Trade Finder and Trade Monitor are designed to follow. Putting on a single Diagonal trade is a speculative Directional trading technique, something we don't practice at Uncle Bob's Money.

A Double Diagonal can be either a DEBIT spread or a CREDIT spread. The price depends on the Volatility and relative pricing of the Options. In practice, trades that start out with close to zero credit or debit can be easier to adjust, but it's not a fixed rule. The decision to enter a Double Diagonal should be judged based on the Expiration graph, not on the initial credit / debit.

Uncle Bobs Money Sample Double Diagonal Trade Graph

The Middle of the graph should never 'sag' below the break-even line (This refers to the BLUE line which is the profit/loss at expiration.). The higher the sag is, the better the trade is, on the condition that we didn't pull our Short Positions in too close to do so.

The goal is to have our Short positions as far away from the Market price as possible, but still maintain a middle 'sag' that is as high as possible.

Double Diagonals ALWAYS have MAINTENANCE. The profit spread of a Double Diagonal is very wide and high; however, there is a corresponding risk that is also high. The amount of maximum loss on a Double Diagonal is like taking the potential loss on both sides of a Condor. Brokers will hold for maintenance the full potential loss which is approximately the same as if you calculate both sides of the 'Condor' spread from this trade.

Let's take our fictitious company AcmePlus as an example. AcmePlus stock is currently trading at $100 per share.

For example, 1 Standard Deviation, according to the June Expiration, is 15 points away. We would put on both a CALL Diagonal and a PUT Diagonal:

CALL Diagonal:

We can Sell the 115 CALL Strike for the JUNE Expiration for $2.00 per share, and we can Buy the 120 CALL Strike for the JULY Expiration for $2.10 per share. [Remember that Options Contracts represent 100 shares of stock.]

=> When we Sell 1 CONTRACT of the JUNE 115 CALL Strike for $2.00, we will get paid $200 immediately into our Brokerage account. (We sold the JUNE 115 CALL for $2.00 PER SHARE, and there are 100 shares in 1 CONTRACT = $200.)

=> When we Buy 1 CONTRACT of the JULY 120 CALL Strike for $2.10, we will have to pay $210 immediately to cover that purchase. (We bought the JULY 120 CALL for $2.10 PER SHARE, and there are 100 shares in 1 CONTRACT = $210.)

=> Our Gross Cost = $10. (We received $200 for the sale of the 1 CONTRACT JUNE 115 CALL Strike, and we paid $210 for the 1 CONTRACT JULY 120 CALL Strike: $200 - $210 = -$10.)

=> The possible gross loss is $500. This is based on the Vertical risk between our Short position at the 115 Strike, and our Long position at the 120 Strike: similar to a Condor.

PUT Diagonal:

We can Sell the 85 PUT Strike for the JUNE Expiration for $2.20 per share, and we can Buy the 80 PUT Strike for the JULY Expiration for $2.35 per share.

=> When we Sell 1 CONTRACT of the JUNE 85 PUT Strike for $2.20, we will get paid $220 immediately into our Brokerage account.

=> When we Buy 1 CONTRACT of the JULY 80 PUT Strike for $2.35, we will have to pay $235 immediately to cover that purchase.

=> Our Gross Cost = $15.

=> The possible gross loss is $500. This is based on the Vertical risk between our Short position at the 85 Strike, and our Long position at the 80 Strike: similar to a Condor.

The maximum possible loss could be slightly higher than $1,000 because of the offsetting month. However, for the sake of calculation we can add up the possible gross loss at each side to calculate the Maximum Loss / Maintenance amount on this trade to be $1,000 total ($500 CALL side + $500 PUT side).

The maximum profit on a Double Diagonal Spread is at our Short Strikes, and the maximum profit at expiration can be well over 50%. Aside from the high profit amounts at Short Strike positions, the Double Diagonal has a very wide area of profit.

We generally only hold Double Diagonal trades for 20 to 25 days, and then we exit. If all goes well, we can expect to exit with a nice profit of 10% to 15%.

We don't ever hold a Double Diagonal spread until Expiration because the settlement value and the Market price of our Long position can be grossly out of sync and we could end up with a large loss, plus we might have to do a lot of fast juggling in our Brokerage account dealing with a Short position that Expires In The Money.

SPREAD TRADES:

When we trade Options, we don't have to go through the process of buying and selling the individual Options of our Double Diagonal or other spread trades. We can make a "Spread" order, where we specify what Options we want to Buy and Sell, and we can say what NET amount we want to get. (See the explanation in the Condor and Calendar sections.)

We will generally get better pricing by trading the PUT Diagonal and the CALL Diagonal separately.

COST & MARGIN REQUIREMENTS:

=> Debit or Credit Spread. It is price dependent, we may pay to enter the trade like a Debit spread, or we can get paid like a Credit spread. If all else is equal, a general guide is to try to enter trades with a minimal cost or debit.

=> Maintenance Requirement: There is Maintenance. The maintenance amount can be roughly calculated by treating each side like a Condor, and ADDING the max loss from both sides together.

HOW WE PROFIT:

We profit on a Double Diagonal trade through the reduction of Time Premium during the 20 - 25 days that we are in the position. The Time Premium of our Short position, which is getting close to Expiration, will drop much faster than the Time Premium of our Long position, which has a more distant Expiration. Our profit will increase at the Short Strikes because the value of our Long Positions as compared to our Short positions will be highest.

HOW WE CAN HAVE A LOSS:

=> When the underlying has unusual price movements in one direction that force us to remove our positions early.

=> When the Implied Volatility (IV) goes down / trends down, then the price of our Options drops, thus eliminating any Time Value decay that we were counting on for a profit.

=> When an IV Skew greater than 4 or 5 develops, which will adversely affect our Options pricing.

PROBABILITIES:

Calendar Trades have probabilities of success generally over 60%.

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Double Diagonal Graph:

Uncle Bobs Money Sample Double Diagonal Trade Graph


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Double Diagonal Example:

The current price of AcmePlus stock is $100 per share.

CALL Diagonal:

We SELL 1 Contract | ACMEPLUS | JUNE | 115 | CALL | $2.00 per share

We BUY 1 Contract | ACMEPLUS | JULY | 120 | CALL | $2.10 per share

GROSS DEBIT = $10 ($0.10 per share)

MAINTENANCE = $500 (Calculated like the possible loss on a Condor, the Vertical difference between our Short: 115 and Long: 120 strikes.)

PUT Diagonal:

We SELL 1 Contract | ACMEPLUS | JUNE | 85 | PUT | $2.20 per share

We BUY 1 Contract | ACMEPLUS | JULY | 80 | PUT | $2.35 per share

GROSS DEBIT = $15 ($0.15 per share)

MAINTENANCE = $500 (Calculated like the possible loss on a Condor, the Vertical difference between our Short: 85 and Long: 80 strikes.)

Double Diagonal Total:

DEBIT = $25

MAINTENANCE = $1,000

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Double Diagonal Trade Finder Rules:

On a Double Diagonal Trade, the SHORT STRIKES are generally placed approximately 1 Standard Deviation away from the Current price based on the Expiration date. We will trade both the PUTs and CALLs; we treat the Double Diagonal as one large spread. If you only trade one side, that would be a Directional Option trade where you are trying to guess the direction of the market, which is what we avoid at Uncle Bob's Money.

Make sure that the 'sag' in the middle of the "Yield at Expiration" graph does NOT go below the break-even line.

Double Diagonal’s are generally held for 20 to 25 days.

The Uncle Bob's Money Trade Checklist and Trade Finder automatically check all the relevant factors.

view: Trade Finder screen shots

TIME FACTORS:

=> Time to Enter Trade: 45 days until 30 days prior to expiration

=> Preferred Time to Enter Trade: 40 days prior to expiration

=> Minimum Time Premium: N/A

=> Earnings and News: On Stocks: no news, no Earnings, no mergers, no splits, no takeovers, etc. Any one of those items can cause the price of the Underlying to jump.

=> Time In Trade: 20 to 25 days.

VOLATILITY FACTORS:

=> Maximum IV: Less than 32.

=> IV Range: Lower 1/3 of the IV range for the last 2 years. Lowest is best.

=> IV Channeling: Channeling for at least 45 days.

=> IV Trend UP: Good.

=> IV Trend DOWN: Bad.

=> IV Skew Range: Between -2 to +5.

PRICE FACTORS:

=> Minimum Underlying Price: $70. If the price of the underlying is too low, the price of the Options will be too low, and there won't be enough Time Premium decay to create a healthy profit.

=> Strike Pricing: Short Strike 1 Standard Deviation away from underlying price. If the IV is "low" we can move in slightly. If the IV is "high" we can move the Short Strikes out more.

=> Minimum Premium: The price of the Short Strike cannot be less than $1.00. The price of the Long cannot be more than 1.5 times the price of the Short.

=> Price Movements in Last Week: +/- 5%

=> Price Movements in Last Month: +/- 10%

=> Price Movements in Last 3 Months: +/- 15%

=> Delta Neutral: N/A

GRAPH FACTOR:

=> The 'sag' in the middle of the "Yield at Expiration" graph should NOT be below the break-even line.

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Double Diagonal Price Negotiation:

=> Beginning traders can put in all 4 legs of the Double Diagonal as one trade to start. It is best to trade one Spread at a time: Trade the CALL and PUT Spreads separately.

=> Determine the highest price to pay or lowest Credit to accept on each Spread before starting to trade. It is best to shoot for Double Diagonals that are as close to zero as possible: a small Debit or Credit is fine. Trades with a large Debit or Credit should be used only for Advanced Double Diagonal Traders.

=> Start at the Mid Price and wait a few minutes. (Be more patient if you have one large order with all 4 legs.)

=> Increase price by the smallest amount possible ($0.01, $0.05, etc.), and wait before changing the price again. Never exceed the highest price limit.

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Double Diagonal Trade Monitor Rules:

The Uncle Bob's Money Trade Monitor automatically shows the profit level for each strategy and checks the relevant factors.

view: Trade Monitor screen shots

=> If the underlying reaches the Expiration break-even point, exit the trade.

=> If the IV Skew goes above 5, exit the trade.

=> If the IV Trend goes down, exit the trade.
See IV drop analysis example

=> If the price movement of the underlying exceeds the Trade Finder values, exit the trade.

=> If the Time in Trade exceeds 25 days, the position should be monitored very closely or exit.

=> If the Time remaining until Expiration is 3 days or less, exit the trade. Do not let a Double Diagonal trade go until Expiration.

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Double Diagonal Suggested Conditional Orders:

The Uncle Bob's Money Trade Monitor automatically shows the suggested break-even points, which are used for placing Conditional Orders.

EXAMPLE:

The current price of AcmePlus stock is $100 per share.

CALL Diagonal:

We SOLD 1 Contract | ACMEPLUS | JUNE | 115 | CALL

We BOUGHT 1 Contract | ACMEPLUS | JULY | 120 | CALL

break-even up-side: 118

(The break-even points are listed on the Uncle Bob's Money Trade Monitor Page.)

PUT Diagonal:

We SOLD 1 Contract | ACMEPLUS | JUNE | 85 | PUT

We BOUGHT 1 Contract | ACMEPLUS | JULY | 80 | PUT

break-even down-side: 82

NOTE: Technically we do Not need to remove both sides of the Double Diagonal at the same time. We can simply remove the side that is problematic, and leave the other side 'live'. However, it is likely that if one side of the Double Diagonal is in trouble, the other side will also be problematic. We calculate the break-even points by treating both sides together as one big trade, so when a break-even point is reached, we remove both sides of the trade. We do this by having 2 conditional orders, and as soon as one order is filled, it will make the other order live so that we will completely close this trade.

It is possible to make one large 4 leg order that will remove all of the positions, but you need to set both the up-side and down-side trigger points. Look at the Butterfly Conditional Order example to see how we set 2 trigger points on one order.

This example is for 2 separate orders, where one order triggers the other:

STEP A) Select "Advanced Trade": 1st Triggers ALL (One Triggers ALL other orders in this group.)

This is critical, because when one of the trades is filled, we want the other order to go live so it will completely close our Double Diagonal position.

STEP B) Down-side break-even:

=> Select the PUT Diagonal Trade, and create a 'closing order'. (You can manually select the opposite spread to close the position if your Broker doesn't have the 'closing order' possibility.)

=> Time in Force: GTC (Good 'Til Cancelled)

=> Price Rules: Market (We don't want to set a limit price, because we don't know what the pricing will be and we want to close this position if the underlying hits our break-even point.)

=> Submit at Specified Market Condition: When the "MARK" of the Underlying is "AT OR BELOW" price of $82.00. (Make sure to use the Down-side break-even as listed in the Uncle Bob's Money Trade Monitor for your own trade.)

Your broker will describe this trade as:

1. Wait until the following condition is satisfied: mark price of the security is less or equal to $82.00. This order will show a WAIT COND status during waiting;

2. SELL -1 DIAGONAL ACMEPLUS JULY/JUNE 80/85 PUT at current market price. The order is valid until it is either filled or cancelled;

STEP C) Up-side break-even:

=> Select the CALL Diagonal Trade, and create a 'closing order'.

=> Time in Force: GTC (Good 'Til Cancelled)

=> Price Rules: Market

=> Submit at Specified Market Condition: When the "MARK" of the Underlying is "AT OR ABOVE" price of $118.00. (Make sure to use the Up-side break-even as listed in the Uncle Bob's Money Trade Monitor for your own trade.)

Your broker will describe this trade as:

1. Wait until the following condition is satisfied: mark price of the security is greater or equal to $118.00. This order will show a WAIT COND status during waiting;

2. SELL -1 DIAGONAL ACMEPLUS JULY/JUNE 115/120 CALL at current market price. The order is valid until it is either filled or cancelled;

STEP D) Confirm that the trade was entered correctly, and submit the trade.

We now have a conditional order that will close our Double Diagonal trade if the underlying price hits ONE of our break-even points.

NOTE: If we decide to manually exit positions, we must first cancel ALL conditional orders that we placed on those positions.

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