- Requires less maintenance margin than the traditional call credit spread
- Can still be profitable both below and above strike price A
- High probability of making $X (though offset with a low probability of losing -$5x)
- Costs more initial capital than traditional call credit spread
- Miss out on bigger payoffs in the event stock drops a lot
- In the low probability event that the stock jumps by a lot, your potential loss is roughly 5x or 6x of what your gain is
During the first week, combining a diagonal spread with a regular vertical call spread at higher strikes could be a good strategy.
For example, if SPY is at 200, then sell SPY 200 weekly call and by the following week SPY 202 call as your diagonal spread. Then sell a vertical weekly call spread by selling the 202 strike and buying the 204 strike–for a tiny credit. This is a tiny credit, but comes with an even higher probability of being profitable (80-90+%).
So in the event that the diagonal spread loses money because the stock goes up too much from 200 and passes the net credit received from that trade on its way towards 202 — as long as it does not pass the 202 strike, then you make money from the vertical call spread.
Real-Life Examples of Diagonal Call Spreads in SPY Options That We Traded
Expectation: S&P would either stay near where it’s at or go down a bit between now and expiration in 9 days. Based on our Elliott Wave Analysis, we did not expect it go down a lot between now and near-term weekly expiration — particular because it is Thanksgiving week and historically, not much usually happens during this week.
What Actually Happened: S&P moved up a little bit, but not a lot. On the day of expiration, S&P dipped towards our Strike A — and we took that opportunity to exit the trade. It wasn’t the perfect max profit of $1,500 we were aiming for, but because of a risk of a bounce, we exited the trade for $1,200 –close to our goal of $1,500.