For more information on the diagonal calendar call spread, check out this article:

Calendar spreads involve buying and selling options on the same underlying security over two different months.   Some people refer to calendar spreads as covered calls on steroids.  When the strike prices of both options are the same, it is a calendar spread.  When the strike prices are different, it’s commonly referred to as a diagonal calendar spread.  Here is the option chain on US Bank showing calls for June and January.

us-bank-diagonal-calendar-call-spread

The option play I recently executed was the following:

  • Buy CALL options in the January 2010 LEAP for US Bank at the 17.50 strike
  • Sell CALL options for June at the 19 strike. (The 20 strikes also look appealing for more bullish traders)
  • The approximate cost is about $310 per spread contract ($440 for Jan 17.50 minus $130 for June 19)

In order to execute this trade, Level 3 (option spreads) options trading is required.  The delta on the 17.50 strike options will be higher than the delta of the 19 strike options.  A higher delta means that if the shares in US Bank explode higher, the LEAP options should gain more value than the June 19 options lose in value.  On the other hand, if the shares in US Bank drop significantly prior to June, then the loss on the spread is significantly less than the loss on the LEAP’s outright.  By spreading the options, the potential gain is reduced, but the potential loss is reduced along with it.  If we are indeed in a tight trading pattern, then it may be possible to continuously ROLL the front month options forward as option expiration approaches, and collect premium month after month after month.

Calendar spreads, whether normal or diagonal, can be adjusted like any other options positions or spreads.   Possible adjustments are some of the following.

  • On an aggressibe stock price dip that is perceived to be temporary, it’s possible to buy back the front month calls (BUY TO CLOSE) for a profit, and let the LEAP’s run naked.
  • On an aggressive stock price rally that is perceived to be long lasting, it’s also possible to buy back the front month calls (BUY TO CLOSE) for a loss, and let the LEAP’s run naked.
  • At or near June expiration, it’s possible to ROLL the front month options forward and collect additional premium.  Rolling would involve buying to close the existing option and selling to open the next month in the cycle (July).
  • The LEAP option can also be adjusted by ROLLing the option UP or DOWN after a big price swing.  Rolling down an option will increase the delta.  Rolling up an option allows the trader to collect some of the premium, and reduce the delta to the preferred target range of delta.  It’s all based on personal preference and your own trading style.

Disclaimer: No accuracy guarantees of anything on this site.  Trade at your own risk.  The above information is *NOT* advise of any kind.