Double Diagonals
A double diagonal spread is the simultaneous trading of two diagonal
spreads: one call spread and one put spread. The distance between the
strikes is the same in both diagonals, and both have the same two expiration
months. Usually, the two long-term options are more out-of-the-money than
the two shorter-term options. For example
Buy 1 XYZ May 70 put
Sell 1 XYZ March 75 put
Sell 1 XYZ March 85 call
Buy 1 XYZ May 90 call
Like many option strategies, the double diagonal can be looked at from a
number of angles. Certainly, this is a trade composed of two diagonal
spreads—the March–May 70–75 put and the March–May 85–90 call. It is
also two strangles—buying the May 70–90 strangle and selling the March
75–85 strangle. One insightful way to look at this spread is as an iron
condor in which the guts are March options and the wings are May options.
Trading a double diagonal like this one, rather than a typically positioned
iron condor, can offer a few advantages. The first advantage, of course, is
theta. Selling short-term options and buying long-term options helps the
trader reap higher rates of decay. Theta is the raison d’être of the iron
condor. A second advantage is rolling. If the underlying asset stays in a
range for a long period of time, the short strangle can be rolled month after
month. There may, in some cases, also be volatility-term-structure
discrepancies on which to capitalize.
A trader, Paul, is studying JPMorgan (JPM). The current stock price is
$49.85. In this example, JPMorgan has been trading in a pretty tight range
over the past few months. Paul believes it will continue to do so over the
next month. Paul considers the following trade: