How to Place a Call Diagonal Spread

Key Concepts

• Call Diagonal Spread: A multi-leg options strategy involving buying a longer-dated call option and selling a shorter-dated call option with a higher strike price. It's a bullish strategy that profits from an increase in the underlying asset's price and time decay, while limiting capital outlay.
• Delta: A measure of an option's sensitivity to a $1 change in the price of the underlying asset. A positive delta indicates that the option's price will increase as the underlying asset's price increases.
• Implied Volatility (IV) Rank: A measure that compares the current implied volatility of an asset to its historical implied volatility over a specific period (e.g., one year). A low IV rank suggests that volatility is relatively low compared to its historical range.
• Net Debit: The total cost of establishing an options spread, calculated as the premium paid for the purchased options minus the premium received for the sold options.
• Time Decay (Theta): The decrease in an option's value over time as it approaches its expiration date. For option sellers, time decay is generally favorable.
• Poor Man's Covered Call: A strategy that mimics a covered call by buying a deep in-the-money call option and selling an out-of-the-money call option with a shorter expiration.

Call Diagonal Spread in Nvidia: Trade Lifecycle

Trade Entry and Rationale

The video details the entry into a call diagonal spread on Nvidia (NVDA) due to specific market conditions and the stock's technical setup.

• Market Context: The E-mini S&P 500 futures were up 32 points, Nasdaq up 230, Dow up 28, and Russell up 14 following a CPI print, indicating a general upside move in the market. However, Nvidia had been underperforming, trading at $136, up only $1 for the day, and showing weakness over the past week, having fallen from approximately $145 to $135.
• Volatility Assessment: Implied volatility (IV) was noted as being low, at 16, with a monthly IV rank of 44. This low volatility environment was identified as an opportune moment to initiate a "long premium position" due to the potential for volatility expansion.
• Strategic Objective: The trader aimed to establish a long delta exposure on Nvidia for a small capital outlay, specifically looking for a bullish play on the stock.
• Strategy Selection: A call diagonal spread was chosen for its capital efficiency compared to buying shares outright. The trader estimated that buying 23 shares of Nvidia at $136 would cost between $2,500 and $3,000, whereas the call diagonal spread would provide similar delta exposure for a significantly lower debit.
• Option Selection Criteria:
  • Long Option: A call option with approximately a 40 delta and an expiration date in the 50-70 day timeframe. The February monthly expiration was selected. The strike price chosen was $145.
  • Short Option: A call option with approximately a 20 delta and a shorter expiration. The January expiration was chosen, and the 155 strike was selected, which had a 19 delta.
• Trade Parameters:
  • Long Call: NVDA February $145 Call.
  • Short Call: NVDA January $155 Call.
  • Net Debit: The initial target debit was $5.76, with the trade ultimately being filled at a $5.79 debit.
  • Delta Exposure: The spread was expected to provide approximately 23 long deltas.
• Initial Fill Difficulty: The trader noted that due to low volatility across the market, it was challenging to get filled on positions.

Trade Adjustment and Management

The video then transitions to discussing the outcome of the trade, which was initiated approximately 72 days prior to the current date.

• Underlying Performance: Nvidia had experienced a significant move higher, reaching around $150, and had even been higher earlier in the day. This move occurred after the CES event, where Nvidia was present.
• Trade Structure Recap: The call diagonal spread was put on when Nvidia was trading around $137. The trade involved buying a longer-dated call (72-day expiration, similar to a "poor man's covered call" setup) and selling a shorter-dated call (37-day expiration) against it for a net debit of $5.79. The spread was 10 points wide.
• Profit Potential: The intrinsic maximum value of a 10-point wide call diagonal spread is $10. However, the trader highlighted that with extrinsic value remaining, the actual profit potential could exceed this if a significant upward move occurred.
• Option Performance Analysis:
  • Long Call (February $145): Purchased at $7.xx, it had increased in value to $12.xx, representing a gain of over $6.
  • Short Call (January $155): Sold at $1.88, it had increased in value to $2.60, an increase of $0.80.
• Benefit of the Short Call (Hedging and Decay): The trader addressed the common concern that the short call caps profits. They explained that the short call's premium decay had worked in their favor, especially during a period when Nvidia's price initially moved lower after the trade was initiated.
  • Downside Protection: When Nvidia moved lower, the short call's premium decayed, hedging approximately $1.30 of the loss on the long call. This meant that instead of losing $2-$3 on a naked long call, the loss was mitigated to around $1.15-$1.50.
  • Extended Holding Period: This hedging effect allowed the trader to hold the position longer, benefiting from the time decay of the short option working in their favor.
• Trade Outcome: The trade was considered a "home run," achieving an almost 100% return on capital (approximately 90%).

Trade Closing and Profit Realization

The trader decided to close the position to lock in profits.

• Closing Strategy: The trade was routed to close at $9.95.
• Fill and Profit: The trade was filled at $9.95, resulting in a profit of $4.16 per share ($9.95 closing price - $5.79 entry debit).
• Profit Calculation: The total profit on the spread was $4.16.
• Market Conditions at Closing: Volatility had increased, as indicated by the IV rank. The underlying price movement had been ideal for the strategy.

Conclusion and Key Takeaways

The call diagonal spread in Nvidia was a highly successful trade, demonstrating the effectiveness of the strategy in a low volatility environment with a bullish outlook.

• Capital Efficiency: The strategy provided significant delta exposure with a limited capital commitment.
• Profitability: The trade yielded a substantial return on investment, close to 100%.
• Hedging Benefit: The short call option provided a valuable hedge against downside movement and benefited from time decay, allowing for greater flexibility and reduced risk.
• Strategic Execution: The selection of appropriate strike prices and expiration dates, coupled with an understanding of market conditions, was crucial for the trade's success.
• Profit Taking: The decision to close the trade at a significant profit was a key factor in realizing the gains.

The trader considered this trade a "home run" and a "big win" in their portfolio.