Making the Most of Your Options
The trader from the previous example had a time-spread alternative to the
diagonal: John could have simply bought a traditional time spread at the
420 strike. Recall that calendars reap the maximum reward when they are at
the shared strike price at expiration of the short-term option. Why would he
choose one over the other?
The diagonal in that example uses a lower-strike call in the February than
a straight 420 calendar spread and therefore has a higher delta, but it costs
more. Gamma, theta, and vega may be slightly lower with the in-the-money
call, depending on how far from the strike price the ITM call is and how
much time until expiration it has. These, however, are less relevant
differences.
The delta of the February 400 call is about 0.57. The February 420 call,
however, has only a 0.39 delta. The 0.18 delta difference between the calls
means the position delta of the time spread will be only about 0.07 instead
of about 0.25 of the diagonal—a big difference. But the trade-off for lower
delta is that the February 420 call can be bought for 12.15. That means a
lower debit paid—that means less at risk. Conversely, though there is
greater risk with the diagonal, the bigger delta provides a bigger payoff if
the trader is right.