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For option spreads, why ought the debit paid $le 75%$ of the strike width?

Diagonal Spread | Definition of a Diagonal Spread | tastytrade | a real financial network

The trade will be entered for a debit. It’s important that the debit paid is no more than 75% of the width of the strikes.

Spread width vs calendar width? : options

If the rule of thumb is premium = 1/3 the width of a spread, what’s the consensus on calendars?

  1. Whence do 75% and 1/3 originate? How do you calculate these percentages?

  2. Which is correct?

Quantitative Finance Asked on February 10, 2021

1 Answers

One Answer

These are just suggested guidelines. The 75% comes from tastytrade (your link) which was founded by Tom Sosnoff. He was a CBOE market maker for 20 years and he created the option platform Thinkorswim which he sold to Ameritrade for $700 million. At a minimum, this guideline comes from his decades of experience and I wouldn't be surprised if he did extensive backtesting to arrive at this number.

Bear in mind that these are just guidelines. When writing against a deep ITM far dated call, you have many choices for the expiration and strike of the near term OTM short call. If you sell a nearer expiration, the premium is less but you have the potential to obtain a higher ROI (more writes), as compared to sell a longer expiration for a non linear larger premium and a lower ROI (fewer writes). You may be less bullish (sell a lower strike) or more bullish (sell a higher strike). It's not as simple as a monolithic decision that 75% determines the months and strikes.

Answered by Bob Baerker on February 10, 2021

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