Diagonal Spread

PMCC (Poor Man's Covered Call) is a specific type of call diagonal spread. It uses a deep ITM LEAPS call as the long option (to mimic stock ownership) and sells shorter-term OTM calls. All PMCCs are diagonals, but not all diagonals are PMCCs - diagonals can use any strike combination and can be puts (bearish) as well.

A diagonal reduces your net cost by selling a shorter-term option. If the stock moves slowly toward your target, the theta income from the short option reduces your break-even. Long calls lose money every day from theta; diagonals can be theta-positive if the stock is near the short strike.

If the stock rallies significantly past the short strike, both options go deep ITM and the spread value compresses. You still profit, but less than if you owned just the long call. You can roll the short strike higher to capture more upside, or close the position and take profits.

For standard diagonals (1 long vs 1 short), maximum loss is approximately the net debit paid. However, if assigned on the short option and you don't manage the resulting stock position properly, losses could theoretically increase. Always have a plan for assignment.

Call diagonal for bullish outlook (expecting rally toward short strike). Put diagonal for bearish outlook (expecting decline toward short strike). Choose based on your market view, just like choosing between buying calls or puts directionally.

Roll if: (1) Stock is at or near short strike (ideal outcome), (2) You still have directional conviction, (3) Back-month has significant time value remaining. Close entirely if: (1) Stock has moved far from both strikes, (2) Thesis has changed, (3) Back-month is approaching expiry, (4) Better opportunities elsewhere.

PMCC uses ~80% less capital (LEAPS cost vs stock cost). Similar theta income potential. PMCC has more leverage (higher % gains and losses). PMCC risk: LEAPS can lose all value; stock can't. PMCC doesn't receive dividends. PMCC requires active management of LEAPS expiration.

If earnings are between expirations, the front-month IV will spike before and crush after. If stock moves significantly on earnings, your spread value can change dramatically. Generally avoid earnings between expirations unless deliberately trading the earnings IV dynamics.

If assigned on short call: You're short 100 shares at strike. You still own the long call. Options: (1) Buy shares to cover, sell long call, close position. (2) Exercise long call to cover short. (3) Hold synthetic put position if bearish. Don't panic - your long option provides protection.

ITM: Higher delta (more stock-like), less leverage, lower risk of losing entire investment, higher cost. ATM: Balanced delta, more leverage, higher risk, lower cost. OTM: Highest leverage, highest risk, lowest cost. Match to conviction level - higher conviction allows more leverage.

Analyze term structure (backwardation premium) AND skew (IV at each strike) across the surface. Calculate expected theta income adjusted for skew. The optimal short strike maximizes (premium from backwardation + premium from time decay) while maintaining acceptable probability of success. Use options analytics platforms for surface modeling.

Monthly rolling (25-35 DTE) captures optimal theta decay curve. Weekly rolling has higher transaction costs but lower gamma risk. Research shows monthly rolling with 30-delta short strike performs well historically. Consider bi-weekly (sell new option every 2 weeks, alternating expirations) for smoother income.

Calculate net delta and hedge with shares. Example: Diagonal has +0.40 delta. Short 40 shares to neutralize. Now you're playing pure theta and vega. Rebalance delta when it moves ±0.10 from neutral. This converts the diagonal from directional to volatility strategy.

Pre-earnings front-month IV is typically 3-8 points above back-month (backwardation). This extra IV is your edge. The short option expires before earnings (no event risk) but captures the elevated premium. Backtest shows this approach adds 1-3% per cycle compared to non-earnings periods.

Calculate delta-equivalent exposure (diagonal delta × 100 shares). Add to portfolio delta. Calculate VaR contribution from diagonal's vega × expected IV change. Position size such that max loss is 2% of portfolio AND delta contribution doesn't exceed 10% of total portfolio delta.