406 Part Ill: Put Option Strategies 
nificant assumption that volatility and interest rates are unchanged). If XYZ trades 
higher than llO, the diagonal spread will lose some of its profit; in fact, if XYZ were 
to trade at a very high price, the diagonal spread would actually have a loss (see Table 
25-4). Whenever the purchased LEAPS call loses its time value premium, the diag­
onal spread will not perform as well. 
If the common stock drops in price, the diagonal spread has the greatest risk in 
dollar terms but not in percentage terms, because it has the largest initial debit. If 
XYZ falls to 80 in three months, the spread will lose about $1,100, just over half the 
initial $2,050 debit. Obviously, the short-term spread would have lost 100% of its ini­
tial debit, which is only $500, at that same point in time. 
The diagonal spread presents an opportunity to earn more money if the under­
lying common is near the strike of the written option when the written option expires. 
However, if the common moves a great deal in either direction, the diagonal spread 
is the worst of the three. This means that the diagonal spread strategy is a neutral 
strategy: One wants the underlying common to remain near the written strike until 
the near-term option expires. This is a true statement even if the diagonal spread is 
under the guise of a bullish spread, as in the previous example. 
Many traders are fond of buying LEAPS and selling an out-of-the-money near­
term call as a hedge. Be careful about doing this. If the underlying common rises too 
fast and/or interest rates fall and/or volatility decreases, this could be a poor strategy. 
There is really nothing quite as psychologically damaging as being right about the 
stock, but being in the wrong option strategy and therefore losing money. Consider 
the above examples. Ostensibly, the spreader was bullish on XYZ; that's why he chose 
bull spreads. If XYZ became a wildly bullish stock and rose from 100 to 180 in three 
months, the diagonal spreader would have lost money. He couldn't have been happy 
- no one would be. This is something to keep in mind when diagonalizing a LEAPS 
spread. 
The deltas of the options involved in the spread will give one a good clue as to 
how it is going to perform. Recall that a short-term, in-the-money option acquires a 
rather high delta, especially as expiration draws nigh. However, an in-the-money 
LEAPS call will not have an extremely high delta, because of the vast amount of time 
remaining. Thus, one is short an option with a high delta and long an option with a 
smaller delta. These deltas indicate that one is going to lose money if the underlying 
stock rises in price. Consider the following situation: 
XYZ Stock, 120: 
Call 
Long 1 January LEAPS 100 call: 
Short 1 April 110 call: 
Position Delta 
0.70 
-0.90