Diagonal Spread

What Is a Diagonal Spread?

A diagonal spread is a modified calendar spread including different strike prices. It is an options strategy laid out by simultaneously going into a long and short position in two options of a similar kind — two call options or two put options — however with various strike prices and different expiration dates.

This strategy can lean bullish or bearish, contingent upon the structure and the options used.

How a Diagonal Spread Works

This strategy is called a diagonal spread since it consolidates a horizontal spread (likewise called a period spread or calendar spread), which includes a difference in expiration dates, and a vertical spread (price spread), which includes a difference in strike prices.

The terms horizontal, vertical, and diagonal spreads allude to the positions of every option on an options grid. Options are listed in a matrix of strike prices and expiration dates. Options utilized in vertical spread strategies are totally listed in a similar vertical column with a similar expiration dates. Options in a horizontal spread strategy, in the mean time, utilize a similar strike prices, yet are of various expiration dates. The options are, subsequently, organized horizontally on a calendar.

Options utilized in diagonal spreads have varying strike prices and expiration days, so the options are organized diagonally on the quote grid.

Types of Diagonal Spreads

Since there are two factors for every option that are unique, in particular strike price and expiration date, there are a wide range of types of diagonal spreads. They can be bullish or bearish, long or short, and use either puts or calls.

Most diagonal spreads are long spreads and the main requirement is that the holder buys the option with the longer expiration date and sells the option with the shorter expiration date. This is true for both call diagonals and put diagonals the same.

Of course, the opposite is additionally required. Short spreads expect that the holder buys the shorter expiration and sells the longer expiration.

What concludes whether either a long or short strategy is bullish or bearish is the combination of strike prices. The table below frames the conceivable outcomes:

For instance, in a bullish long call diagonal spread, buy the option with the longer expiration date and with a lower strike price and sell the option with the close to expiration date and the higher strike price. A model is purchase one December $20 call option and the simultaneous sale of one April $25 call.

Special Considerations

Typically, these are structured on a 1:1 ratio, and long vertical and long calendar spread brings about a debit to the account. With diagonal spreads, the combinations of strikes and expirations will shift, yet a long diagonal spread is generally put on for a debit and a short diagonal spread is set up as a credit.

Likewise, the least complex method for utilizing a diagonal spread is to close the trade when the shorter option terminates. Notwithstanding, numerous traders "roll" the strategy, most frequently by supplanting the expired option with an option with a similar strike price however with the expiration of the longer option (or prior).

Features

• Diagonal spreads permit traders to develop a trade that limits the effects of time, while likewise taking a bullish or bearish position.
• It is called a "diagonal" spread since it joins elements of a horizontal (calendar) spread and a vertical spread.
• A diagonal spread is an options strategy that includes buying (selling) a call (put) option at one strike price and one expiration and selling (buying) a subsequent call (put) at an alternate strike price and expiration.