This is a high probability, low risk addition to a diagonal spread. First off, a diagonal spread is exactly like a stock covered call. Use CF as the example. you could buy 100shares and then sell a front month short call to collect the premium, or you could buy a lets say 2014dated 100strike call for considerably less than 100 shares and then also sell a front month short call to collect premium.. no added margin needed, just like a covered call.
i have 2014 DITM (deep in the money) call and had a Jan 140 short call that i sold when stock was at 130. now $35points higher i rolled the jan 140 to the Feb 140 for a small credit. the feb140 is going for about $26 ($2600). Just as some people own stock that they will hold no matter what, i will hold the LEAP no matter what, so the daily/monthly swings (ie. value) are not that important. with a diagonal my strategy is to capture the monthly premium of the short call and be able to participate in some of the upside movement of the stock by holding the LEAP. so really the only part of a diagonal i need to worry about on a monthly basis is the short call (the Feb140). like i said, the feb140 is going for about $2600.. now i will look to add a credit put spread to that short call. remember i am ignoring the LEAP since i will hold that till 2014 anyway.
I will look for an entry on credit put spreads at/below that short call strike of 140. Use the 135/140 spread as example. at this moment could probably sell for about .50 credit.. so for the usual 10lot would be $500 credit with max loss of $4500. conveniently lines of with weak support line, but now consider if stock pulls back and closes at 135 on feb opex. two things happen, the put spread is at near max loss which i will just roll down and out or roll flat to next month AND the short feb140 call expires worthless (max profit to me of $2600). So obviously the short call is essentially a hedge against the credit put spread.. so my potential max loss from this "position" is only $1900 ($4500 minus $2600). you can also look at it like the short call profit helps pay for any increased lots you add if you have to roll the put spread to next month.
Additionally if i roll the losing puts i will also resell another short call. no added margin needed since it will be getting back into a diagonal spread with the previously held and ignored LEAP. This is not some foolproof revolutionary new technique that i discovered and created a cool name for, i only do this if i have a diagonal where the stock has taken off and im only collecting a few bucks to roll..ie the short 140 call in this example is way in the money so there is not much time decay/time value for me to get. the diagonal will be a low money gainer since its run so far. i guess you could do this when the short call is not in the money but that will reduce the premium protection (the hedge) significantly. The point of what im doing is to have a significant hedge, giving me almost a free shot on the credit put spreads.
So heres the actions to take at FEB opex:
a. stock closes above 140, close credit put spreads for profit or let expire at max profit, buy back short call for profit and roll to next month(which i would have done anyway regardless of if i had credit put spreads)
b. stock closes below 140, roll credit put spreads either flat or down and out adding enough lots to make is for zero cost or credit, which is what i would do with any credit put spread that closed down, regardless if i had short call or not. Buy back the short call for .05 or let expire at max profit, and look for opportunity to resell short call in the next month
This might not be for everyone but it has been a 90%+ winner for me in the past. i will be looking to put this on when CF pulls back a bit closer to moving averages. Yes, i know the value of the LEAP will go down if it drops to under 140..but again i am ignoring near term movement since i will be holding till 2014.