ORDER THE TRADER’S COMBO
Some traders rely on strategies that
combine positive time decay (theta) and
defined risk. Positive theta might be beneficial in that time is on your side, all else
being equal, and defined risk might deliver
the confidence that no matter what a stock,
index, or market does, a trading loss won’t
exceed a size you can know when you enter
One typical trader’s combo is the iron
condor. (See Figure 1.) It has positive theta,
defined risk, and limited deltas, as long as
options are far enough out of the money
(O TM). It’s a market-neutral strategy you
can use when you expect a stock or index
price to stay in a range—specifically, between
the strike prices of a short call and short put
of an iron condor.
Now, the credit you receive when you sell
an iron condor can be higher when volatility
(vol) is higher, all things being equal. And
that credit is the max potential profit of
the iron condor, which impacts how much
positive theta it has. This can make the credit
important. Yet, when VIX is under 20, and
the implied vol of individual stocks is low,
iron condors might not deliver the credits
you hunger for.
It’s kind of like seeing meat and potatoes
on the menu, but in appetizer-sized portions that won’t fill you up. But never fear.
When your meat-and-potatoes iron condor
needs to be more filling in a low-vol market,
you can stretch it out by tweaking the strategy in a way that still maintains positive
time decay and defined risk. On to the next
dish: double diagonals.
The double diagonal (Figure 2) is an iron
condor stretched across two expirations. It’s
short an O TM call and OTM put within the
same expiration, and long a further OTM
call and O TM put.
The double diagonal takes those long
OTM calls and puts to a further expiration.
So, the double diagonal’s short call and put
are in an expiration with fewer days to expiry (DTE), and its long call and put are in an
expiration with more DTE.
For example, with XYZ at $40 per share,
an iron condor could be a long 37 put, a short
38 put, a short 42 call, and a long 43 call,
with 30 DTE. A double diagonal would be
short the 38 put and 42 call with 30 DTE,
and long the 37 put and 43 call, with 60 DTE.
Like the iron condor, the double diagonal is
designed to profit if the stock price stays in a
range between the strike prices of the short
call and put, which in this example would be
between $38 and $42. The double diagonal
also has positive theta and defined risk.
All things being equal, the positive theta of
the short 38 put and 42 call with 30 DTE will
be greater than the negative theta of the long
37 put and 43 call with 60 DTE. Here, theta
grows as the option approaches expiration.
Theta is also higher when the option is closer
to the money. In this case, the 38 put and 42
call with 30 DTE have higher theta than the
37 put and 43 call with 60 DTE, and the short
38 put and 42 call give the double diagonal
net positive theta.
The double diagonal also has defined risk.
No matter how high or low the stock price,
the double diagonal’s max risk is the difference between the long and short strikes (
either calls or puts), minus any credit received,
or plus any debit paid, including transaction
costs. If you created the double diagonal in
XYZ for a $0.20 credit, the max risk would
be $38 – $37 – $0.20, or $0.80, or $80 per
double diagonal. If you paid a $0.30 debit for
the double diagonal, the max risk would be
$38 – $37 + $0.30 = $1.30, or $130 per double
diagonal, plus transaction costs. Those max
losses happen if the stock falls below the
long put strike, or sits above the long call
strike ($37 or $42 in this example) at the long
So, what does the double diagonal do that
the iron condor doesn’t? By pushing the long
options to a further expiration, the double
diagonal can have positive vega, meaning an
increase in implied vol can benefit it. An iron
condor has negative vega, so an increase in
implied vol can hurt an iron condor position,
all things being equal.
FIGURE 1: Profit curve of the iron condor.
FIGURE 2: Profit curve of the double diagonal.
Bread ’n’ butter. Meat ’n’ potatoes. Rice ’n’
beans. When you’re hungry, you may rely on
combinations of staple foods to deliver
satisfying deliciousness. There’re some slight
variations on the basic recipe. But when
you see them on a menu, you can usually be
fairly certain you’ll get a reliable, hearty meal to
keep body and soul humming.