Diagonal Calendar Call Spread

How Does Diagonal Calendar Call Spread Work in Options Trading?

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Diagonal Calendar Call Spread - Introduction

The Diagonal Calendar Call Spread, also known as the Calendar Diagonal Call Spread, is a neutral options strategy that profits when the underlying stock remains within a very tight price range, reaching its maximum profit potential when the stock moves slightly higher.

Like all Calendar spreads, the Diagonal Calendar Call Spread profits through the difference in time decay between options with different expiration months. Because the Diagonal Calendar Call Spread has a long term call option in place, it can be rolled forward for multiple months, eventually lowering or eliminating the cost of buying the long term call options.

Another advantage of the Diagonal Calendar Call Spread is that it is a debit spread while most neutral options strategies are credit spreads which requires margin.

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Types of Calendar Call Spreads

The Diagonal Calendar Call Spread is one of two types of calendar spreads utilizing only call options. The other one is the Horizontal Calendar Call Spread which produces a higher profit if the underlying stock remained totally stagnant. As such, if the underlying stock is expected to remain totally stagnant, the Horizontal Calendar Call Spread would be a better choice.

Differences Between Diagonal Calendar Call Spread and Horizontal Calendar Call Spread

The Diagonal Calendar Call Spread produces a higher maximum profit and a wider profitable range than a Horizontal Calendar Call Spread. This is because the Diagonal Calendar Call Spread allows the underlying stock to move upwards. That increases the value of the long term call options, increasing maximum profitability. Even though the Diagonal Calendar Call Spread has a higher maximum profit potential, it produces a lower profit than the Horizontal Calendar Call Spread if the underlying stock remains totally stagnant. This is because the Diagonal Calendar Call Spread reaches its maximum profit potential only when the stock moves upwards and not when it is completely stagnant. The Diagonal Calendar Call Spread also requires a higher net debit due to the lower offset value of out of the money call options, decreasing ROI. Everything in options trading is a trade-off. Diagonal Calendar Call Spreads also have an assymetric risk graph, incurring its maximum loss (the net debit) only when the stock falls strongly. If the stock rallies strongly, the Diagonal Calendar Call Spread would make a much lower loss than the Horizontal Calendar Call Spread. As such, a Diagonal Calendar Call Spread options trading strategy should be used when a stock is expected to remain within a tight price range with the potential to move moderately higher.

When To Use Diagonal Calendar Call Spread?

Diagonal Calendar Call Spreads are used to profit from stocks that are expected to remain stagnant or move up slightly for the short term while keeping a long term call option position in place in case of future breakouts.

How To Use Diagonal Calendar Call Spread?

In a Diagonal Calendar Call Spread, at the money (ATM) long term calls are bought and then Out of The Money (OTM) near term call options are written against them.

Buy Long Term ATM Call + Sell Short Term OTM Call

Diagonal Calendar Call Spread Example Assuming QQQQ trading at $45 now. Buy To Open 10 contracts of QQQQ Jan 2008 $45 Call options at $4.70. Sell To Open 10 contracts of QQQQ Jan 2007 $46 Call at $0.50. Net Debit = $4.70 - $0.50 = $4.20

Trading Level Required For Diagonal Calendar Call Spread

A Level 3 options trading account that allows the execution of debit spreads is needed for the Diagonal Calendar Call Spread. Read more about Options Account Trading Levels.

Profit Potential of Diagonal Calendar Call Spread :

The Diagonal Diagonal Calendar Call Spread makes its maximum profit potential when the stock rises to the strike price of the short term call options upon expiration of the short term call options.

Profit Calculation of Diagonal Calendar Call Spread:

The value of a Diagonal Calendar Call Spread during expiration of the short call options can only be arrived at using an options pricing model such as the Black-Scholes Model because the expiration value of the long term call options can only be arrived at using such a model.

Diagonal Calendar Call Spread Example Assuming QQQQ closes at $46 upon expiration of the short term call options. The 10 contracts of QQQQ Jan 2008 $45 Call options is now trading at $5.00. The 10 contracts of QQQQ Jan 2007 $46 Call expired worthless. Net Profit = $0.50 (total premium gained from the Jan 2007 $45 Call) + $0.30 (profit on long term call options) = $0.80 x 1000 = $800.

Loss Calculation of Diagonal Calendar Call Spread:

The Diagonal Calendar Call Spread makes it maximum possible loss, which is the net debit paid, when the underlying stock falls drastically. The premium earned from writing the short term call options serve as a hedge against the drop in value of the long term call options.

Conversely, when the underlying stock rallies, the out of the money call options gain in value only slightly faster than the long term at the money call options, resulting in a much lower loss than if the underlying stock falls. This is unlike a horizontal calendar call spread where maximum loss is the same whether the underlying stock rallies or falls.

Risk / Reward of Diagonal Calendar Call Spread:

Upside Maximum Profit: Limited

Maximum Loss: Limited
(limited to net debit paid when stock falls strongly)

Diagonal Calendar Call Spread Breakeven Calculation:

The breakeven point of a Diagonal Calendar Call Spread is the point below and above which the position will start to lose money if the underlying stock rises or falls strongly and can only be calculated using the Black-Scholes model.

Advantages Of Diagonal Calendar Call Spread:

Higher profit can be attained when the stock moved moderately higher.

Can be rolled forward for as many months as the expiration month of the long term call options.

Losses are limited to the net debit.

No Margin Needed.

Disadvantages Of Diagonal Calendar Call Spread:

Profits are limited.

Maximum profit lower than Horizontal Call Time Spread if stock remains stagnant.

Alternate Actions for Diagonal Calendar Call Spreads Before Expiration :

1. If you wish to profit from a rally in the underlying asset, you could buy back the short call options before it expires and allow the LEAPS Call Options to continue its profit run.

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