Thread by @optionsiq_in

{ weekend webinar } diagonal spreads and their profitability !!

definition -> A diagonal spread is an options strategy established by simultaneously entering into a long and short position in two options of the same type (two call options or two put options) but with different strike prices and different expiration dates.

typically the ratio is 1:1 per option trading manuals , and we can adjust the ratio as per wish !!

the idea is long dated options are fairly priced , while the short dated options are mispriced !! but thats the theory , we will find it out soon

on every weekly option expiry , we model on bank nifty options as we have both weekly data and monthly data for the last 3 and half years or so !!

interruptions from wifi and guest !!

rules 1) current day is weekly option expiry day ,
2) we short the weekly dated ATM CE ( nearest 100 ) , and long the monthly dated ATM CE ( nearest 500 , as thats where the liquidity )

3) during the last week of the month , where both weekly exp and near monthly are same ( we take rest for the whole week , or perhaps learn a new skill , #fyi , currently am learning aikido )

1) Short ATM Weekly Bank Nifty CE + Long ATM Monthly CE , and let both expire at respective expire or get assigned --- > (Ratio 1:1)

as it is more or less buying monthly calls from our pocket , as every week we need additional funding to buy the monthly call , we will tweak that ratio to short one weekly CE and buy half CE of the monthly expiry

2) Short ATM Weekly Bank Nifty CE + Long ATM Monthly CE , and let both expire at respective expire or get assigned --- > (Ratio 1:0.5)

we are now in line with bank nifty performance , if you look at the benchmark vs our strategy of short weekly ATM and take the funding and buy half contract a of monthly ATM CE

now we experiment with other strikes on the monthly CE's , like ATM+500 ( so we get a bit high leverage )

now as we selecting a different strike , we can get back to our job of trading from learning aikido and all such bullshit ( as these are of no use at this age of early 40's , frankly speaking !! )

3) Short ATM Weekly Bank Nifty CE + Long ATM +500 Monthly CE , and let both expire at respective expire or get assigned --- > (Ratio 1:1)

as we get an average credit of aporx 50 points per week , ( the differential between weekly short CE and long OTM monthly CE)

so we try to increase the leverage of our OTM monthly CE to a point where our average weekly credit almost becomes zero

that point is about 1.3 , that for every weekly ATM Short CE , we can buy 1.3x of monthly CE's ( and our average net credit per week is zero )

Short ATM Weekly Bank Nifty CE + Long ATM +500 Monthly CE , and let both expire at respective expire or get assigned --- > (Ratio 1:1.3)

further increasing the leverage by buying an ATM+1000 ( lotto monthlies )

Short ATM Weekly Bank Nifty CE + Long ATM +1000 Monthly CE , and let both expire at respective expire or get assigned --- > (Ratio 1:1)

this gives us an average credit of 150 pts per week , so we go to a point where get an avg of zero credit per week , that ratio goes to 1:3 ( that is short 1 weekly CE , and buy 3 monthly ATM+1000 CE's )

Short ATM Weekly Bank Nifty CE + Long ATM +1000 Monthly CE , and let both expire at respective expire or get assigned --- > (Ratio 1:3)

at 2x leverage ( that is if Bank Nifty is at 30k levels , to short one weekly CE , we require about 600K , so at 2x to short 1 CE , we assume we require 300K )

since Jun 2016 till Sep 2019 ->
Initial Capital10000000
Final Capital31376550
CAGR41.47
MDD-21.06
Max Loss %-5.36
Max Gain %23.33

vs a quick and dirty Bank Nifty 2X leverage ->
Initial Capital10000000
Final Capital26686894
CAGR34.69
MDD-28.64
Max Loss %-11.01
Max Gain %24.25

looks fine , but the equity curve is horrible ->

Bank Nifty time spend under water ( that is number of weeks below the peak equity point ) ->
Total Weeks173
Under Water138
% Under Water80

vs our strategy ->
Total Weeks173
Weeks under water154
% weeks Under water89

this long convexity exits only the call side , how much ever hard you try on the put side its a losers game !!

why ?? , as the covered call crowd tends to supply calls irrespective of the market fear or greed , while the put buying crowd after a lotto profit tends to over pay for OTM put options , thus giving back those gains made in the subsequent weeks !!