Stock options are a leveraged trading
vehicle for traders. There is a specific term that measures the level of the
leverage. It is called Omega. Omega measures the relative percentage changes
between the stock and the option, and is used as an elasticity measure for the
option. The formula to calculate Omega is given below.
Omega =
Option Delta * (stock price / option price).
As the stock price rises, the value of
the long call option increases. The Delta of the long call also increases up to
a maximum value of 1 eventually. Once the Delta approaches 1, the most
significant contributor to the option leverage level is the option price as it
changes in larger percentages than the stock price, according to the above
formula. Therefore, the leverage of a call option decreases as its stock prices
rise to deep inthemoney (ITM).
In a similar principle, the option leverage decreases for diagonal call spreads
when the stock prices go further deep ITM while the short call strike remains
outofthemoney (OTM). This is exactly what happened to my QQQ
Diagonal Call Spread.
To keep sufficient option leverage, I rolled out the long call from July to September and reduced the Delta of the long call from 0.9 to approximately 0.65, which is my initial long Delta at the entry of my diagonal call spreads. On Tuesday May 30th, I sold the original long call and bought a new call for a credit of $2.82.
The rolling adjustment to the diagonal call spread allowed me to take a profit of $2.82 and extend the life of my diagonal spread by more than 2 months. I can use the extended time to sell call options a few more times and receive additional premiums when needed to compensate for the option time decay.
The adjusted diagonal call spread also reduced its position Delta from 0.6 to 0.4. This was desirable for a stock that had risen consecutively in the last 7 days and I expected a pullback soon. The pullback would cause less profit drops as the Delta was reduced. In the meantime, if the stock price continued to climb, the profit increase would be less as well. This scenario could be changed with the uncovering (buying back) of the short call though.
The QQQ diagonal entry and rolling history up to now is shown in the table and marked in the stock chart below.
To keep sufficient option leverage, I rolled out the long call from July to September and reduced the Delta of the long call from 0.9 to approximately 0.65, which is my initial long Delta at the entry of my diagonal call spreads. On Tuesday May 30th, I sold the original long call and bought a new call for a credit of $2.82.
The rolling adjustment to the diagonal call spread allowed me to take a profit of $2.82 and extend the life of my diagonal spread by more than 2 months. I can use the extended time to sell call options a few more times and receive additional premiums when needed to compensate for the option time decay.
The adjusted diagonal call spread also reduced its position Delta from 0.6 to 0.4. This was desirable for a stock that had risen consecutively in the last 7 days and I expected a pullback soon. The pullback would cause less profit drops as the Delta was reduced. In the meantime, if the stock price continued to climb, the profit increase would be less as well. This scenario could be changed with the uncovering (buying back) of the short call though.
The QQQ diagonal entry and rolling history up to now is shown in the table and marked in the stock chart below.
Date

Spread

Side

Exp

Strike

Price

Net Price

Pos Effect

Total Cost

4/5/2017

SINGLE

BUY

21Jul17

130

5.86

5.86

TO OPEN

5.86

4/12/2017

SINGLE

SELL

5May17

133

0.8

0.8

TO OPEN

5.06

4/24/2017

DIAGONAL

SELL

19May17

136

0.58

1.14

TO OPEN

4.48

BUY

5May17

133

1.72

DEBIT

TO CLOSE

6.2


5/1/2017

SINGLE

BUY

19May17

136

1.86

1.86

TO CLOSE

8.06

5/17/2017

SINGLE

SELL

9Jun17

139

0.85

0.85

TO OPEN

7.21

5/25/2017

DIAGONAL

SELL

16Jun17

143

0.57

2.05

TO OPEN

6.64

BUY

9Jun17

139

2.62

DEBIT

TO CLOSE

9.26


5/30/2017

DIAGONAL

BUY

29Sep17

135

8.86

2.91

TO OPEN

18.12

SELL

21Jul17

130

11.77

CREDIT

TO CLOSE

6.35

In summary, the leverage of options is
related to the strike price compared with the stock price:
 Deep ITM options have less leverage than ATM & OTM options
 ATM options have less leverage than OTM options and more leverage than ITM options
 OTM options have more leverage than ATM & OTM options
Increasing leverage usually means
taking more risks for stock investments. However, this is not necessary true
with the rolling diagonal spread trading strategy, as described in the example
of this post. The main reasons are outlined below.
 The rolling of the long option takes some profit out and leave less money on the table.
 The rolling of the long option gives the position more time for selling additional premiums.
 The rolling of the long option reduces overall position Delta and makes it less susceptible for stock price drops and smoother for profit gains.
The catch is
that the new position will profit less before the long Delta approaches 1
again. This scenario happens with less probability though.
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