Chapter 23: Spreads Combining Calls and Puts 3S3 
strategy discussed in this section is merely a combination of a diagonal bearish call 
spread and a diagonal bullish put spread and is known as a "diagonal butterfly 
spread." The same concept that was described in Chapter 14 - being able to make 
more on the short-term call than one originally paid for the long-term call - applies 
here as well. One enters into a credit position with the hope of being able to buy back 
the near-term written options for a profit greater than the cost of the long options. If 
he is able to do this, he will own options for free and could make large profits if the 
underlying stock moves substantially in either direction. Even if the stock does not 
move after the buy-back, he still has no risk. The risk occurs prior to the expiration 
of the near-term options, but this risk is limited. As a result, this is an attractive strat­
egy that, when operated over a period of market cycles, should produce some large 
profits. Ideally, these profits would offset any small losses that had to be taken. Since 
large commission costs are involved in this strategy, the strategist is reminded that 
establishing the spreads in quantity can help to reduce the percentage effect of the 
commissions. 
SELECTING THE SPREADS 
Now that the concepts of these three strategies have been laid out, let us define 
selection criteria for them. The "calendar combination" is the easiest of these strate­
gies to spot. One would like to have the stock nearly halfway between two striking 
prices. The most attractive positions can normally be found when the striking prices 
are at least 10 points apart and the underlying stock is relatively volatile. The opti­
mum time to establish the "calendar combination" is two or three months before the 
near-term options expire. Additionally, one would like the sum of the prices of the 
near-term options to be equal to at least one-half of the cost of the longer-term 
options. In the example given in the previous section on the "calendar combination," 
the near-term combination was sold for 5 points, and the longer-term combination 
was bought for 8 points. Thus, the near-term combination was worth more than one­
half of the cost of the longer-term combination. These five criteria can be summa­
rized as follows: 
1. Relatively volatile stock. 
2. Stock price nearly midway between two strikes. 
3. Striking prices at least 10 points apart. 
4. Two or three months remaining until near-term expiration. 
5. Price of near-term combination greater than one-half the price of the longer­
term combination.