The million dollar answer would be to test this out in real time with real skin. And btw, are you trading the same strike? Or spreading the risk? Your example $XXX you are selling the front month, buying the back, it looks like a classic calendar not a diagonal?
I did back in 2013/14. Not too profitable. I found trading straight got me better results. For this newbie, managing/analyzing a single is already too much to handle, if I then added another leg, the combination was just too complex for me to analyze. My question to you sir is how do you analyze the diagonal as to optimum set up, probability it will go your way, against you and probability of ending where it ends? I appreciate any coaching you can give me. Thanks.
I don't. This is more of a defensive strategy. This strategy 70% of the time, you'll make LESS if you were to just go same expiration. The benefit is you will lose a lot less if the trade was to go against you. It's good for if you think the market is topping out but still want a piece of the action. I think back in 2013/14 you were using a binary strategy where you are either right or wrong. Thus it wouldn't be as profitable if you were right, but did you compare your losses? My initial question was if you keep selling ATM or slightly ITM Puts/Calls using the remaining long option as a hedge, your profits should be more than a regular spread. But the hedge you get from the remaining option will get more tenuous as you keep doing this. However the risk profile will still be the same. I do regular spreads too, they work well. I'm just always on the look out for a good strategy. Any prop options trader would probably know this strategy like the back of their hand though, it shouldn't be anything new.
I trade diagonals, and your initial post is not clear enough (with respect). An actual trade example would have helped. Your -XXX and +XXX example looks like a calendar cos there is no mention of expiries. I'm currently trading UVXY diags and have holdings in others. Diagonals are cousins of the calendars, and I prefer the latter far more. I trade cals in abundance. The reason for choosing the diags over a calendar is that I can play around with theta and vega much more and find the strikes/expires that suit my risk/rewards needs for that trade. Diags are also more directional - if the underlying moves in the wrong direction too much, they can go horribly wrong. I did a lot of diags on the SPX and TLT in March/April when the volatility was very high. Those trades worked out beautifully, but in today's mid-20's VIX they will not work. Your SPY example is risky as all it will take is one incidence of the SPY moving down and your profits from the previous X trades will be gone - selling a ATM put that expires tonight may seem easy money if the SPY rises today, but it's very gemma sensitive and directional. Once this put goes ITM, it will gain value much faster than the long put (which is more OTM), resulting in loss. The key to both cals/diags is the volatility difference between the shorts/longs. They cannot be mechanically opened every Mon and expected to perform in the same way week after week. Specific market conditions need to be taken into account. Good luck.
I explicated stated that if the trade was to go against you, it'd be a losing trade but it will be less than if you were to trade a same expiration spread. However, if the trade goes in my favor, I would gain more value than same expiration spread otherwise, since ATM options have higher premiums. It's not risky if my loses are limited to what I gained initially. However, I understand if I lose on my very first sell and it expires ITM. And no strategy works all the time - But right now for the current market, it seems to work fine and if the dow drops 10,000 tomorrow, my losses are still the same - it's not a terrible strategy. I don't have any fancy tools to measure vega except for the options themselves and VIX. Volatility has been dying throughout the years. It has only recently picked up due to economic uncertainty but in a bad way. Market would go up constantly lowering volatility than when sell off happens it breaks historical records. Feb 2018, Oct - Dec 2018, and now March 2020. I'm sure there'll be more sell offs after Nov that'll break even Covid lows in a mere month. Than it'll rally again to the moon. Are put Calendars more attractive than Calls? Since you prefer them over diags. Puts usually have more vega.
Anyway since I started this thread, I'll put this to the test with AMD today. Since it's expiration, I didn't see any reason not to sell ATM after I bought the 65 long. I would have rolled it anyway if it expired ITM. I closed 68 prematurely since AMD kept rallying, I figured it might close above 69. So I only have the July 31st Short and Aug 21st Long for now. My max loss if this wasn't a diagonal would be -$4.5. But since I don't have any IV tools, I don't know what the value of the 65 put would be if it were to go below. It would be a loss for sure though. However, if the 72 put expires worthless next week ( I doubt it ), the profit would be $6.00 plus whatever is left of the Aug 65. If it closes in between, I'll keep rolling it.