A double diagonal spread is an advanced options strategy that combines two diagonal spreads - one with calls and one with puts. This creates a position that profits from time decay while having protection on both sides. It is one of the most flexible income strategies available to options traders.
What is a Double Diagonal Spread?
A double diagonal spread consists of four options: two long-dated options (a call and a put) and two short-dated options (a call and a put). The long options are typically in-the-money or at-the-money, while the short options are out-of-the-money. All four options have different strike prices and different expiration dates.
Simple version: Think of a double diagonal as running two income-generating machines at once - one for upside moves and one for downside moves. You collect premium from short-term options while your long-term options provide protection and allow for multiple rounds of income.
How to Construct a Double Diagonal
The double diagonal has four legs:
- Long call: Buy a longer-dated, lower strike call (typically ITM or ATM)
- Short call: Sell a shorter-dated, higher strike call (OTM)
- Long put: Buy a longer-dated, higher strike put (typically ITM or ATM)
- Short put: Sell a shorter-dated, lower strike put (OTM)
Double Diagonal Example
Stock XYZ is trading at $100. You set up a double diagonal:
Call diagonal side:
- Buy 1 June $95 call for $10.00
- Sell 1 March $110 call for $1.50
Put diagonal side:
- Buy 1 June $105 put for $9.00
- Sell 1 March $90 put for $1.50
Net debit: $10 + $9 - $1.50 - $1.50 = $16.00 ($1,600)
Premium collected from short options: $3.00 ($300)
Profit zone at March expiration: Stock between $90 and $110
Why Trade Double Diagonals?
- Dual income streams: Collect premium from both call and put sides
- Wider profit zone: Profitable across a larger price range than single diagonals
- Defined risk: Long options cap your maximum loss
- Neutral to slightly directional: Profits if stock stays in range
- Repeatable income: Sell new short options each month against your long positions
- Volatility flexibility: Can profit from IV changes
The Income Generation Process
The power of double diagonals comes from repeatedly selling short-term options:
- Month 1: Sell March calls and puts, collect $300
- March expiration: If stock stays in range, both short options expire worthless
- Month 2: Sell April calls and puts, collect another round of premium
- Repeat: Continue selling monthly options until June expiration
Key insight: If you collect $300 per month for 4 months, you bring in $1,200 in premium. This significantly reduces your cost basis from $1,600 to just $400, dramatically improving your break-even point.
Managing the Position
When Short Options Expire
At each short-term expiration, you have decisions to make:
- Stock in the range: Both short options expire worthless. Sell new ones.
- Stock near upper strike: Roll the short call up and out. Keep or adjust short put.
- Stock near lower strike: Roll the short put down and out. Keep or adjust short call.
- Stock breaks out significantly: Consider closing the entire position or adjusting the long options.
Adjusting Strike Prices
As the stock moves, you may need to adjust your short strikes:
- Stock trending up: Move both short strikes higher
- Stock trending down: Move both short strikes lower
- Stock oscillating: Keep strikes centered around current price
Risk Analysis
Maximum Loss
Your maximum loss is limited to the net debit paid minus any premium collected. This occurs if the stock makes an extreme move and your long options lose most of their value.
Maximum Profit
Maximum profit at short-term expiration occurs when the stock is between your short strikes. Over time, your maximum profit is the total premium collected from multiple rounds of short options minus the decay in your long options.
Profit and Loss Scenarios
Using our example with $16.00 initial debit:
- Best case: Stock stays at $100, you collect 4 months of $300 premium = $1,200. Long options retain most value. Net profit: $800+
- Good case: Stock drifts to $95 or $105, collect partial premium each month. Modest profit.
- Bad case: Stock breaks to $85 or $115 quickly. Short options lose value, long options retain some protection. Small loss or break-even.
- Worst case: Stock gaps to $70 or $130. Long options provide some protection but significant loss occurs. Maximum loss: approximately $1,000-$1,400.
Double Diagonal vs Double Calendar
- Double calendar: Same strikes on long and short options. Profits if stock stays at strike.
- Double diagonal: Different strikes. Wider profit zone but higher cost.
- Risk profile: Double diagonal has more directional flexibility.
- Complexity: Double diagonal is more complex to manage.
Double Diagonal vs Iron Condor
- Iron condor: Same expiration for all options. One-time premium collection.
- Double diagonal: Different expirations. Multiple premium collection opportunities.
- Capital efficiency: Iron condor typically requires less capital.
- Management: Double diagonal requires more active management.
- Profit potential: Double diagonal can generate more total income over time.
When to Use Double Diagonals
- Range-bound markets: Stock expected to stay within a range for several months
- High IV environment: Elevated volatility means more premium to collect
- When you want income with protection: The long options provide a safety net
- During earnings season: Sell short options before earnings, hold long options through
- On stable, liquid underlyings: Best on indexes or large-cap stocks with tight bid-ask spreads
Tips for Trading Double Diagonals
- Choose liquid underlyings: Four legs means you need tight spreads
- Buy long options 3-6 months out: Gives you multiple income cycles
- Sell short options 30-45 days out: Optimal time decay
- Keep short strikes 1 standard deviation OTM: Balance between premium and probability
- Track your collected premium: Know your adjusted cost basis
- Have adjustment rules: Decide in advance when and how you will adjust
- Close before long expiration: Do not let time decay eat your long options
Track Your Double Diagonals
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Summary
The double diagonal spread is an advanced income strategy that combines two diagonal spreads for premium collection on both sides of the market. By buying longer-dated options and repeatedly selling shorter-dated options against them, you can generate consistent income while maintaining defined risk. The strategy works best in range-bound, higher volatility environments and requires active management to maximize returns.
Learn about related strategies: diagonal spreads and iron condors.