Call Calendar vs. Short Call Diagonal

Below is an approximation of the values of a Call Calendar spread vs. a 5-point wide short Call Diagonal. I’ve compared the 2 strategies over a 1 week period of time. If I bought a 1% OTM Fri/Mon spread with 14 DTE and held it for 1 week what could I expect the value to be if SPX was up, down, or unchanged during that week? See the results.

Since the short Diagonal is so much cheaper than the Calendar it’s not surprising that it out-performs the Calendar if SPX moves lower or is unchanged on the week. But what might be surprising to some people is that it out-performs the Calendar even if SPX is up about .5% on the week. The only outcome where the Calendar does better than the short Diagonal is if SPX is up closer to 1% on the week. That should make sense since the Calendar has greater positive Deltas and is a more bullish trade. Most of the risk of the short Diagonal is in the right tail of the risk profile. That’s reflected in the $500 margin requirement for the short Diagonal. When calculating the risk/reward of the trade don’t forget to factor in that margin requirement!

How did I arrive at those estimates? Simply by simulating the values on the risk profile. Below is the Calendar risk profile.

Below is the short Call Diagonal.

Below is the current SPX option chain that I’m using to estimate the value of the Monday option after the previous Friday’s expiration.

I’ll let you do your own comparison to figure out how the 10-point wide short Diagonal compares. Those are often bought for a credit so there’s no downside risk.

If I thought the SPX chart was looking bullish I’d tend to trade that with the Calendar and, if SPX rallied, I might either roll that Calendar into a 5-point wide short Diagonal for a credit or add a new trade either using the same long strike as the Calendar or possibly a further OTM strike. One other note; I’ll often trade both at the same time. Instead of doing multiple lots of the Calendar or short Diagonal, doing half-size of both often works well for me!

12/10 Update: SPX closed today at 6035 so it has dropped 55 points in the 2 days since the above analysis took place. Below is a risk profile as of today’s close showing the Calendar, which was worth $2.25 is now worth $1.35 and the short Diagonal, which was worth $.65, is now worth $.50. This reinforces the point made in this post. The short Diagonal can withstand a move lower in SPX much better than a Calendar.

12/15 Update: Doing some comparison shopping for some SPX bullish trades. Options are leveraged products which is why their potential gains and losses can be so much greater than the underlying instrument that they are based on. Below I’m going to take the leveraged discussion up a notch. I can buy an OTM Call Calendar that expires this coming Friday (5 trading DTE) for $1.40 or the 5-point wide short Call Diagonal with same long Call and same expiry for $.55. That is shorter duration than most of my trades (typically 14-28 DTE) but just go with me for purposes of this example. See the risk profile below showing a 1-lot of both spreads combined. Often, instead of deciding which one I’m going to trade I buy both. Just something to think about.

Below is the most current SPX option chain that I’m using to estimate the value of the spreads. Remember, don’t trust the SPX risk profile!

Below is a comparison of the Calendar and short Diagonal with a little twist. Since the Diagonal has just $.55 of downside risk while the Calendar has $1.40 I could actually buy 3 of the Diagonals for about the same amount of downside risk as the 1 Calendar ($1.65 vs. $1.40). The leverage offered by a 3:1 ratio would offer a huge upgrade in the maximum potential profit. If I did a 3-lot of the short Diagonals and SPX was between 6080 and 6125 at Dec20 expiry the Diagonals would show the greater profit. In fact, it could be a significantly greater profit! Great, I’ll just load up on short Diagonals, right? Before I answer that, look at the bottom of each column and we’ll discuss down below.

The margin requirement on the Calendar is $0 so the most I can lose is the amount I paid for the spread (approximately because slippage in exiting the trade and commissions can add to the loss). That puts the maximum amount of the loss around $160-$170. The margin requirement on the short Diagonals is $500 per lot. So if I did that 3-lot the margin requirement is $1,500 and my loss could be as high as around $1,700 counting the initial cost of the trade, slippage, and commissions. That’s a lot of risk. That is why I’d never do a trade like that if there was a likelihood of a big move up in SPX. Examples are when the Fed makes an interest rate announcement or an important economic indicator is scheduled to be released. I also don’t do those Diagonals on stocks prior to earnings announcements. I do like this type of trade on SPX if the index is in an uptrend but is approaching technical resistance near the area of the long strike (in this case 6125). Or, if I’m expecting a melt-up in the index!

Ask questions down below and remember, this isn’t a trade suggestion, it’s a exercise in understanding how to lower initial cost and control/manage risk while attempting to maximize potential profits. It’s also designed to help you understand the various components of risk. Do not make any trade unless you completely understand everything that could go right, and more importantly, what could go wrong in that trade!