“Diagonals” are a refinement of calendar spreads. As such, we will briefly consider the nature of such spreads and the reasons for their use without going into greater detail.
What does diagonal mean? A diagonal line goes up or down as well as across; it is a combination of horizontal and vertical. Intuitively, then, what is a diagonal spread? A spread that is a combination of a horizontal spread (same series, same strike, different expiries) and a vertical spread (same series, same expiry, different strikes).
A call diagonal is a spread where a shorter-dated call is traded against a longer-dated call with a different strike.
A put diagonal is a spread where a shorter-dated put is traded against a longer-dated put with a different strike.
An example of a call diagonal is the Sep 5525/Dec 5625 call diagonal. This diagonal consists of two legs (highlighted in the table), either buying the Sep 5525 call against selling the Dec 5625 call or vice versa. The value of this spread is 114 ticks (equivalent to £1140) per one lot of the spread, the difference between the prices of the two calls.
If we buy the Sep 5525/Dec 5625 call diagonal at 114, we are buying the (longer-dated) Dec 5625 call at 207 and simultaneously selling the (shorter-dated) Sep 5525 call at 93 against it. We are part-financing our purchase of the Dec 5625 calls by selling the Sep 5525 ...