Diagonal Spread Example:

Sell GGBBU            Feb 2009    7.5 Call            $0.35

Buy KDMAZ            Jan 2010   2.5 Call             $4.40

 

Net Cost                      $4.05(+Trading Costs)

 

Maximum Loss            $4.05(+Trading Costs)

 

GGB is trading for        $6.54 at the close on Tuesday 01/27/09

 

If GGB trades above $7.50 on February 21, 2009 the gain will be $0.95(Less Trading Costs).  Lets assume $0.50/share trading costs, the return would be approximately 11% for 25 days.  Not Bad, but this is not what I am looking for.

 

If GGB does not go above $7.50, AND

 

If GGB trades at $6.54 on January 16, 2010 the loss would be $0.01(+Trading Costs), however this assumes that you do not sell more call options during the year.

 

If GGB trades much lower, this is the worst case scenario, however GGB is trading near its lows for the past year.  The Maximum Loss is $4.05(+Trading Costs) no matter what happens to GGB.

 

If GBB trades much higher, the return will depend if there are any outstanding options that have been sold.  At some point, if GGB trades much higher and you still own the $2.5 options, we can protect some gains by buying puts.  Let’s see where it moves.

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