Tuesday, February 28, 2012

A Breakdown of Diagonal Spread Advantage vs Covered Call $AAPL

heres why i like diagonal spreads..say you have the cash to buy 100shares of $AAPL at about 533.($53000). you would like to get some monthly income and write some covered calls, the Apr 565 call is going for about $10 ($1000)... so you profit from stock going up to 570, almost $40 worth of upside. not bad, closes under 560 you keep the stock and the $1000 from short call..good coin.. instead look at the following, using that same $53000:

buy 3 Jan2014 400 calls for about $170 each ($17000 each)

so for almost the same amount of money you control 300shares worth of stock via a deep-in-the-money (DITM) Leap.. since you own the calls you can SELL short term calls against it for no added margin..just like a covered call with stock, so now:

sell 3 Apr 565 calls for about $10 each ($1000 each)

so you collect $3000 on these short calls vs just $1000 on a covered call with stock. the 2014 call has a .80delta so your call moves .80 for every 1.00 of stock move so you benefit from upside move as well.. more so since you have 3calls vs just 100shares.

1. stock closes below 565, keep the short call premium and sell calls again the next month, and repeat every month just like you would with a covered call.
2. stock takes off, can either roll the short calls or close out both legs of diagonal
3. stock drops alot..can add ratio spreads as trade repair month to month or keep selling short calls...its a 2014 leap so you have 2years to do this every month, every earnings, every ipad refresh announcment, etc

its not for everyone but for me its a better use of the cash i have...$3000 call premium off of $50000 investment every month is not bad.

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