What’s a double diagonal? How can you use this handy options strategy in your trading? In this, the first post in a three-part series, we’ll explore how double diagonals got their name (and explain a few of those funny names of other options strategies).
I’m delighted to announce that TradeKing has recently added “Double Diagonals” to our trading menu. That seems like a great opportunity to introduce and explain this strategy a bit.
The double diagonal strategy is a cousin of the iron condor. The trade has the same neutral market outlook of an iron condor and with the added benefit of rapid time decay. That is, this trade capitalizes on the fact that the front-month option decays at a faster rate than the back-month option. This is definitely a veteran option trader strategy.
Let’s start by explaining the name – why “double diagonal”? If you’ve spent any time trading options you’ve probably noticed the colorful names for various strategies. Some of the names’ origins are pretty unexplainable, like condor or butterfly. The best guess I can give you is that someone looked at a profit and loss graph at expiration of a strategy and said, “Duh, I think that graph looks like a butterfly”. And the name just stuck.
Some options strategy names, however, have a clearer origin – the quote board on the trading floor. Double Diagonal is one of those names. To explain the name, first we need to set up a quote board similar to the one we might see on the trading floor and start with some more basic trades. Across the top horizontally are the different expirations available on one underlying; vertically you see the strike prices of specific options. On a real quote-board on the floor, there would be separate sections for puts and calls, but let’s just combine them here for simplicity’s sake.
The first trade, highlighted in gray, consists of a Buy of the May 70 call and a Sell of the May 75 call. This strategy usually goes by the names “long call spread”, “bull call spread” or “debit spread”. But market makers on the floor usually refer to it as a vertical spread – why, you ask? Because when you look at the quote board, the trade is spread vertically across the board.
The next trade, highlighted in blue, includes a Sell of a May 80 Put and a Buy of a June 80 Put. This strategy is known to most traders as a “calendar spread” or “time spread”. Can you guess what market markers refer to this trade as? Right – a horizontal spread, because it goes horizontally across the board. You’re getting the general picture, right?
Next trade up is highlighted in gray again, a Sell of a May 90 Put and a Buy of a June 85 Put – that’s a diagonal across the board, so you can guess what it’s most commonly called. That leads us to today’s topic, the double diagonal. The next trade down, highlighted in blue, involves a Sell of the May 95 Call and a Buy of the June 100 Call. If we combine both of these diagonals -- a Sell of a May 90 Put and a Buy of a June 85 Put, plus a Sell of the May 95 Call and a Buy of the June 100 Call – there’s your double diagonal. Ta da!
What’s that trade highlighted in green? Consisting of four legs -- a Buy July 85 Put, Sell July 90 Put, Sell July 95 Call and Buy July 100 Call – this strategy is most often referred to as an Iron Condor. Is that because its P&L graph looks like a condor? Maybe. The only rhyme and reason behind the name is that a an actual condor has a wide wingspan and the strategy happens to have a large area in which it is profitable (see graph below) compared to that of its sister trade, the butterfly.
Why is it an “iron” condor? My friend Marty Kearney has a good theory: it might be named for the band called Iron Butterfly that formed in 1968 and became very popular in the early 70s, when the CBOE trading floor first opened in 1973. Marty is an instructor with the CBOE who traded on the floor back in those days (sorry to date you, Marty). The difference between an “iron” and ordinary “condor” is that the iron version is made with a combination of puts and calls; a regular condor can be either all calls or all puts. 
So why did I toss in condors just now? First of all, I want to float a new name for this trade, the double vertical. After all, this technically fits in more with the quote-board naming strategy we’ve been exploring.
That was the fun reason, but I really wanted to point out that most traders that do double diagonals start out as iron condor traders and put on the double diagonal as an offshoot of an iron condor. The concept is to try to take advantage of the fact that options decay more rapidly in the front months than the back months. In our double diagonal outlined above the sale of the call and put are in the May month and the buy of the call and put are in the June month. If the trade is going well at the May expiration – and by well I mean the stock is between 90 and 95-- most double diagonal traders would roll the May options to June and have an iron condor in place for the month of June. More to come on that concept later.
I hope this post sheds some light on why options trades are named as they are. My next post will dig into specific ways double diagonals can best be worked into your overall trading strategy.
Regards,
Brian Overby
TradeKing's Options Guy
www.tradeking.com
[image: The Pits by dcwriterdawn on flickr]
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