The Complete Guide to Option Strategies: Advanced and Basic Strategies on Stocks, ETFs, Indexes, and Stock Indexes

CHAPTER 18

Diagonal Spread

A diagonal spread strategy consists of options with different strike prices and expiration dates. To illustrate basic principles, this chapter will address a diagonal spread in which one option is at-the-money and another option is out-of-the-money, where an equal number of options are bought as are sold. Examples are presented showing results at the expiration date of the near-term option. This chapter will cover long and short diagonal spreads.

OVERVIEW

A diagonal is a spread with different strike prices and different expiration dates, such as buy one XYZ February 100 call and sell one XYZ March 110 call. A diagonal consists of either all call or all put options. There can be a large number of variations of a diagonal spread, so each should be analyzed separately to determine the risks and rewards. It is difficult to generalize about the characteristics of a diagonal spread as you can with other spread strategies. However, for the purposes of this book, it is assumed that a diagonal spread behaves mostly like a calendar spread, which was analyzed in Chapter 17.

Like a calendar spread, a diagonal spread can take advantage of near-term time decay relative to longer-term time decay or longer-term time decay relative to near-term time decay. A diagonal spread can consist of the purchase of a call (or put) option and the simultaneous sale of a call (or put) option with different strike prices and expiration dates. Likewise, a diagonal spread can consist ...