SMB CAPITAL OPTIONS TRAINING PROGRAM

1. SMB CAPITAL OPTIONS TRAINING PROGRAM

2. SESSION ELEVEN Double Diagonal Spreads

3. Double Diagonals Basics • Double diagonals are simply front month strangles, with protected by back month longs. • Double diagonals are a cross between a condor ( a strangle ) and a calendar (back month longs). • Because the back month longs survive expiration of the front month shorts, they maintain value • Double diagonals are very sensitive to changes in volatility as are calendars. Volatility changes can permanently affect the double diagonal income potential, unlike the front-month only condor, where volatility changes are always, ultimately, temporary.

4. Double Diagonal at Initiation

5. Analyze Graph of Double Diagonal at Initiation

6. Double Diagonal Trade Initiation • Enter days 30-40 prior to expiration. • Shorts generally in the 20-30 delta region • Longs adjusted for volatility bias (farther out less vega, closer in more vega). • Probability of profit in the region of 60% • Approximately 15% return potential at outset of trade--minimum. • Skip months where can not get this combination of returns/probability of profit.

7. About debits or credits • Double diagonals can be a credit or debit. Don’t worry about it. If the longs are more expensive than the shorts, it will be a debit and the reverse is true for a credit. One is not better than the other. • The farther you draw your wings from your shorts, the more likely the trade will be a credit. The closer the wings to the shorts, the more like the trade will be a debit. • What is important is the return/probability of profit.

8. Double Diagonal Trade Plan • If the market hits either short strike or the position P and L is down 50% of the maximum gain potential of the trade (in the middle of the “smile”), roll enough threatened shorts as far as you need away from the money to cut deltas in half then… • Roll the entire “good side” diagonal closer to the money, but no closer than the original shorts were to the market at trade initiation—to add theta which was depleted by the roll of the shorts. • If trade never adjusted, which can happen in certain months, target profit is 60% of the maximum possible on the gain at expiration. • If trade is adjusted, must reduce profit target to 50% of max gain, 7 days before expiration on adjusted analyze graph. • Max loss should be set at 100% of possible gain on trade initiation graph in the “middle of the smile”.

9. Adjustment point reached

10. Trade down 50% of max loss

11. Step 1: Cut deltas in half

12. Flatter deltas but little profit potential

13. Rolling “good” side diagonal for additional theta

14. Reasonable returns restored

15. GOOG rallies further to new short strike

16. Again, first halve deltas

17. Then add theta

18. Despite a significant rally…..

19. ..Closed for reasonable profit

20. Homework • Utilizing Optionvue’sbacktrader module, select any January over the last five years and place a double diagonal utilizing DIA as the vehicle, initiating and adjusting the trade according to the adjustment techniques mentioned in this lesson for 12 straight months. Set up a specific account for this in Optionvue and note your gains or losses for each month. Set up an X/L spreadsheet with 12 rows for each month and columns representing: initial trade risk/reward, implied volatility at trade inception, distance between put side short and call side short, distance of wings to shorts and return in dollar and percentage terms. • Do the same in the OIH • Pick a stock with a market price greater than $100 and do the same exercise, avoiding earnings months.