Hedging the Short Call Diagonal

Below is my current Jan17/21 short SPX Call Diagonal. This is the standard 3-day (Fri/Mon) position that I always use but since Jan20 is a market holiday then this 4-day position becomes the standard for this position only.

Because SPX has moved lower I have a $2,700 open profit on the position. The initial cost was a $200 credit so there is no downside risk. The upside risk is the $80,000 margin req. minus the $200 credit so $79,800. The $2,700 open profit represents a 3.4% return on risk over 9 days (trade was entered on 12/31). That equates to a 138% annual return on risk.

This was the fill on the Jan17/21 Double Diagonal.

I could take that profit now on move on to the next Fri/Mon expiry of Jan24/27 or I could hedge some of that upside risk by adding some long Deltas to the position. Or I could do both! At the bottom of the post I show both adjustments but first I want to deal with adjusting just the current position.

Below is one adjustment I could make. There is a summary after the fourth risk profile so you can see how each of these adjustments compare.

Below is the second adjustment.

And the third adjustment is below.

And the fourth and final potential adjustment is below.

The original cost of this position was a $200 credit so there was no downside risk. Below is the result of making any one of those four adjustments shown in the risk profiles above.

1. Buying back 2 of the short 6040 Calls in Jan17 expiry. Cost: $1,500 Margin req. $68,000
2. Buying 2 additional long 6050 Calls in Jan21 expiry. Cost: $1,700 Margin req. $70,000
3. Buying back 4 of the short 6090 Calls in Jan17 expiry. Cost: $1,000 Margin req. $76,000
4. Buying 2 additional long 6100 Calls in Jan21 expiry. Cost: $1,240 Margin req. $80,000

I’ll leave it to you to decide which adjustment makes the most sense. You could also say why even make an adjustment? Either leave it alone and see how it performs over the coming days or exit it now with that 3.4% return on risk. Those are both potential beneficial outcomes but if you look at that risk profile again you’ll notice I have a rather large bearish position in the March monthly OpEx. I’ve been hedging that with some /ES futures Calls but enough time has passed so now is a good time to utilize this Call Diagonal as a hedge over the next week.

Finally, below is one way in which layering positions on top of each other can help manage risk and potentially increase profits. In this example buying back 4 of Jan17 SPX 6040 short Calls costs $3,000. If I also bought a 32-lot of Jan24/27 SPX 5990/6000 short Call Diagonals I would receive a $3,040 credit. Combining the two trades leaves me with a $40 credit (basically pays the commissions) so it adds no downside risk.

Questions? Comments? Leave them down below.