Diagonal Calendar Spread Trades

Another version of the calendar spread is the diagonal spread, which uses a different strike price in the front-month option than in the back month. The basic idea is to select the long option to have a strike price that is out-of-the-money compared to the strike price of the short option. This reduces the cost of the calendar and in some cases even creates an initial credit.

The diagonal spread trade frequently works best when the two strike prices are no more than $2.50 apart, because it keeps the maximum risk on the trade at a reasonable level. This means restricting this type of trade to either low-priced or some medium-priced stocks, as well as various indexes that have closely spaced strike prices.

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