Double Diagonal – Neutral Strategy
The Double Diagonal is a neutral stock options strategy. The Double Diagonal strategy is similar to an Iron Condor and can be considered a combination of a Calendar Call spread and a Calendar Put spread.
The Calendar Put spread portion of the Double Diagonal is entered by selling an out-of-the-money put option and purchasing a further out-of-the-money put option having an option expiration further out in time.
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The Calendar Call spread portion of the Double Diagonal is entered by selling an out-of-the-money call option and purchasing a further out-of-the-money call option having an expiration further out in time.
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Another way to look at a Double Diagonal is an Iron Condor which has been “diagonalized”.
Advantages of a Double Diagonal over an Iron Condor:
- Potentially lower brokerage fees and commissions
- Increase in volatility increases attractiveness of position
- Increased profit potential at short put option and call option strike
- Less risk/smaller potential losses with wider breakeven range
Similar NDX Iron Condor and Double Diagonal positions will be analyzed in order to illustrate the differences between the two strategies.
The NDX Iron Condor position selected to be analyzed is shown below:
Buy 10 contracts of $NDX 2010 MAR 1,600.00 PUT @ $4.20 $4,200.00
Sell 10 contracts of $NDX 2010 MAR 1,625.00 PUT @ $4.90 ($4,900.00)
Sell 10 contracts of $NDX 2010 MAR 1,950.00 CALL @ $1.45 ($1,450.00)
Buy 10 contracts of $NDX 2010 MAR 1,975.00 CALL @ $1.00 $1,000.00
The NDX Double Diagonal position selected to be analyzed is shown below:
Buy 1 contract of $NDX 2010 APR 1,475.00 PUT @ $4.10 $410.00
Sell 1 contract of $NDX 2010 MAR 1,625.00 PUT @ $4.90 ($490.00)
Sell 1 contract of $NDX 2010 MAR 1,950.00 CALL @ $1.45 ($145.00)
Buy 1 contract of $NDX 2010 APR 2,050.00 CALL @ $0.70 $70.00
The short put options and short call options are identical for the two positions with the long options having different months of expiration. The long options for the Iron Condor position have a month of expiration of March and the month of option expiration for the Double Diagonal long options are in April.
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Brokerage Fees & Commissions
For this example, the Iron Condor position was entered with 10 contracts, whereas a similar Double Diagonal position was entered with only 1 contract. An investor may be able to realize reduced brokerage fees and commissions when investing with the Double Diagonal over the Iron Condor.
The long options for the Double Diagonal being further out in time than for the Iron Condor presents a nice advantage for the Double Diagonal over the Iron Condor with respect to an increase in volatility. An increase in volatility will have a larger impact on the long options for the Double Diagonal than for the long options for the Iron Condor. An increase in volatility will cause the value of the long options for the Double Diagonal to increase more than the respective long options for the Iron Condor resulting in increased profitability for the Double Diagonal. Additionally, the increased sensitivity of the Double Diagonal to volatility spikes results in smaller losses for the Double Diagonal when exiting a position due to a stop-loss.
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Capital Requirement and Special Margin
The capital requirement for both positions is about $24,000 with potential returns in the 4.5% to 4.8% range. The Iron Condor position can take advantage of special margin since the difference between the put spread and call spread is the same (25) and the month of expiration for all of the options is the same (March). Since the Iron Condor can only suffer a loss for either the put spread or the call spread, some brokers allow for special margin for Iron Condors if the months of expiration for all the options the same and the put and call spread differentials are identical. Conversely, the Double Diagonal position does not qualify for special margin since the month of option expiration for all options is not the same. For the Double Diagonal, the month of expiration for the short options is March and the month of expiration for the long options is April.
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The profit and loss charts for a similar NDX Iron Condor and NDX Double Diagonal position for expiration in March of 2010 are shown below:
Breakeven – Iron Condor vs. Double Diagonal
The lower break-even price of $1,612 for the Double Diagonal is smaller and more advantageous than the larger break-even price of $1,624 for the Iron Condor. Similarly, the upper break-even price of $1,957 for the Double Diagonal is higher and more advantageous than the break-even price of $1,951 for the Iron Condor.
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Loss of Capital
Since the Iron Condor position takes advantage of special margin, the position can realize a total loss of capital if the price of NDX closes below the short put strike of 1,600 or above the long call strike of 1,975 at option expiration. In contrast, the Double Diagonal does not qualify for special margin and the largest loss the Double Diagonal can suffer is about 50% which occurs if the price of NDX closes below $1,475 or above $2,050 at option expiration.
The break-even prices for the Double Diagonal are more advantageous than for the Iron Condor, but the difference is really pretty small, less than 1%. However, the differences for the prices of maximum capital loss are significantly better for the Double Diagonal than the Iron Condor, on the order of 4% to 8%.
To summarize, the Double Diagonal position has a similar return as the Iron Condor with less risk. At this point, the Double Diagonal appears to a better strategy than the Iron Condor, however, the Double Diagonal does have some disadvantages when compared to the Iron Condor.
Disadvantages of a Double Diagonal compared to an Iron Condor:
- Special margin not available
- Decreased profit potential near midway point between option short strikes
- Return calculation is not straightforward
- May require significant capital for implementing with indexes
Double Diagonal – No Special Margin
As discussed earlier, the Double Diagonal cannot take advantage of special margin as in the case of the Iron Condor. The Iron Condor can basically generate twice the return of the Double Diagonal for a given amount of capital invested.
Iron Condor Profitability Region
As can be observed from the profit/loss charts, the Iron Condor has a very uniform profitability region between the short option strike prices with a very sudden drop off in profitability (or loss) with underlying prices lower than the short put strike price or higher than the short call strike price.
Double Diagonal Profitability Region
In contract, the Double Diagonal experiences the most profit when the price of the underlying is near one of the short option strike prices at expiration. Additionally, and in contrast to the Iron Condor, the profitability of the Double Diagonal is not uniform between the short option strike prices and dips or drops near the midway point between the short options.
Straightforward Potential Return Calculation
For the Iron Condor, the potential return calculation assumes all of the Iron Condor options will expire worthless, so the calculation is very straightforward. However, since the short options for the Double Diagonal have a shorter timeframe for expiration, the potential return calculation is more complicated, as the price of the long options have to be calculated or estimated in some manner. This calculation is generally performed using the Black-Scholes option pricing model which is somewhat complicated and will not be discussed in this article.
Capital Requirement and Tax Advantages
For the example NDX positions selected, the minimum amount (one contract) that could be invested with the Double Diagonal was about $25,000, whereas the Iron Condor could be entered with a capital requirement (one contract) of about $2,500. Alternatively, a similar Double Diagonal position with a smaller capital requirement could have been entered for the QQQQ ETF. However, a Double Diagonal for an ETF would not be subject to some of the tax advantages available for a Double Diagonal position with an index as the underlying. More information is available for the tax advantages of Broad-based Index Options at this website: Tax Advantage.
The Double Diagonal strategy is a very powerful and flexible stock options strategy. The strategy is a neutral strategy with the potential to work in low volatile markets while providing an attractive risk/reward profile.
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[tags] Double Diagonal, Iron Condor, Calendar Put, option expiration, Calendar Call, spread, out-of-the-money, brokerage fees, volatility, strike, NDX, expiration, strike price [/tags]