Option Strategies

Diagonal Spread

Remember our discussion on Calendar Spreads? Well if you didn't read that, please click here to read up on that because a Diagonal Spread is simply another form of a Calendar Spread.

Okay so now you've brushed up on Calendar Spreads, let us continue. So remember that a Calendar Spread is basically a type of Vertical Spread but instead of varying on the price, the two Call Options (or Put Options) vary based on the expiration month. Also remember that Calendar Spreads are typically a net debit transaction. So now what if you thought a Calendar Spread was too expensive for you to take on? Well there is a way for you to finance the cost of a Calendar Spread and it's called a Diagonal Spread. Let's see the table below to make this easier to understand.
The above table represents a typical Calendar Spread. Notice that you still end up paying a net debit of $2.2. If you want to lower that cost you will need to sell a Vertical Call Spread. Here is a table representing the Vertical Call Spread.
The first thing to point out is that the second leg of the Vertical Spread cancels out the second leg of the Calendar Spread. So we are still left with maintaining two open positions in this spread. One for April $200 and one for March $195. So you see both the expiration date and the strike price differ in this spread. That is why it is called a Diagonal Spread. Also you will notice that the net debit spread has now turned into a net credit spread of $0.90.

The scenarios where you would make a profit is still the same as in the Calendar Spread you read about earlier. The only different factor is the strike price is different now and you end up getting money for taking this position.

Another thing to mention is that you do not have to manually enter into a Calendar Spread AND a Vertical Spread. That would be too expensive in terms of commissions. Your broker should have the ability to buy/sell Diagonal Spreads as one unit. The tables above were just for illustrative purposes.

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