A previous article on the diagonal spread trade pointed out how this strategy incorporates the best features of the vertical spread and the horizontal spread while avoiding some of the drawbacks of each.
In the previous article and updates of that article, the diagonal spread trade was illustrated with Procter& Gamble (PG) call options. It was also discussed how the trade could be continued forward by utilizing weekly options. The discussion here provides a final update and conclusion of the diagonal spread.
In early June with PG trading near $78, it was anticipated that the stock price might be moving up over the next six weeks in anticipation of a strong earning report on August 1. To guard against some time loss in a long call option while waiting for the stock to move up, a diagonal spread with PG call options was selected.
Original Trade (6/11): Buy 1 July (monthly) 75 call for $3.60 and sell 1 June (monthly) 80 call for $.35 for a net cost of $3.25.
First Continuation (6/21): With PG trading around $77.50, the June (monthly) 80 call expired worthless. The June (weekly exp 6/28) 80 call was sold for $.15, reducing the cost basis of the July (monthly) 75 call down to $3.10.
Second Continuation (6/28): With PG trading around $77, the June (weekly exp 6/28) 80 call expired worthless. The July (weekly exp 7/5) 80 call was sold for $.10, reducing the cost basis of the July (monthly) 75 call down to $3.00.
Third Continuation (7/5): With PG trading around $78.50, the July (weekly exp 7/5) 80 call expired worthless. The July (weekly exp 7/12) 80 call was sold for $.25, reducing the cost basis of the July (monthly) 75 call down to $2.75.
Conclusion (7/12): During the week of July 8-12, there was a 4.1% surge in the price of PG stock which closed at $81.55 on Friday (7/12). With the July (weekly exp 7/12) 80 call in-the-money by $1.55, it was time to close the diagonal spread. Even though the long option in the diagonal spread still had another week before it expired, it was best to view the diagonal as a vertical spread that had achieved its maximum possible return. Under these circumstances, the only sensible action was to exit the trade.
Near the close of trading on July 12, the diagonal spread could be closed for a net of $5.30. This included an extra $.30 of time value in the long call that still had another week before expiration. Using the cost basis of $2.75 going into the last week of the trade, the profit of $2.55 represented a yield of 93%.
This PG trade was a good illustration of how the diagonal spread can utilize the best features of the horizontal and vertical spread strategies. Like a horizontal spread, it repeatedly captured premium from selling weekly options. Then when the stock price moved so that both legs were in-the-money, the diagonal spread functioned like a vertical spread that had achieved its maximum profit.
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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.