A strategy idea for options trading investors.

TRADE COMMENTARY: An Exxon Mobil Diagonal Call Spread

We are bullish on Exxon Mobil (NYSE: XOM), which will report earnings on July 29. After earnings there are three scenarios for the stock: it will be higher, lower, or unchanged.

If the stock is higher, this position will profit from being long the XOM August 77.5 Calls. These calls will expire into stock, that is, we will be assigned the shares at 77.5. That transforms the position into a covered call (long 100 shares of stock at 77.5, short 1 XOM Oct 85 Call), leaving us with upside potential all the way to 85.

If the stock is lower, the maximum we can lose is the premium paid for the call spread, at which time the entire spread should be sold for whatever premium we can receive for selling it.

If the stock is unchanged, the implied volatility in the August and October options will be lower. We will benefit from this with the October call, which should offset losses from lower implied volatility and time decay in the August call. The position will still be worth holding as the long August 77.5 call will be in the money and providing upside profit potential.

TRADE: EXXON MOBIL (NYSE: XOM) DIAGONAL CALL SPREAD

DATE: June 29, 2011

STOCK/INDEX: XOM

STOCK PRICE: 79.50

NEXT ESTIMATED EARNINGS REPORT: July 29, 2011

OPTION PLAY: Diagonal Call Spread

SELL/STRIKE/MONTH/PRICE: 1 October 85 Call @ $1.30

BUY/STRIKE/MONTH/PRICE: 1 August 77.5 Call @ 3.70

NET COST: 3.70 – 1.30 = $2.40

BREAK EVEN: 77.5 + 3.70 – 1.30 = $79.90 at August Expiration

Long Strike + Debit – Credit = Break even

MAX PROFIT: 85 – 77.5 – 3.70 + 1.30 = $5.10

Short Strike – Long Strike – Debit + Credit = Profit

MAX LOSS: 3.70 – 1.30 = $2.40

Debit – Credit   =  Loss

Stutland Equities is a premier futures and options trading company on the Chicago Board Options Exchange. Founded in 2005 and headquartered in Chicago, Stutland Equities specializes in volatility arbitrage across multiple asset classes.