Diagonal Spread

The diagonal spread is a popular options trading strategy that involves the simultaneous purchase and sale of options of the same type but with different strike prices and expiration dates. This spread aims to benefit from the advantages of both vertical and calendar spreads.

The strategy offers traders greater flexibility compared to other options strategies, allowing them to take multiple positions and potentially purchase options at a lower cost. However, it is important to note that, like all options trading strategies, the diagonal spread carries associated risks, such as losing money if the underlying security does not perform as expected. Additionally, traders may incur higher fees than other strategies, as they effectively buy and sell two options contracts.

• The diagonal spread strategy in options trading involves buying and selling options of the same type but at different strike prices and expiration dates.
• This spread strategy's main goal is to utilize the advantages of both the vertical and calendar spread techniques while trading options. 
• It is different from the calendar and vertical spread. In the calendar spread, only the expiration dates are different, and in the vertical spread, strike prices are different.
• The types of diagonal spreads include diagonal call and put spreads.  

A diagonal spread is a type of options spread that combines aspects of both horizontal spreads and vertical spreads. By using options with different strike prices and expiration dates, the strategy can help lower costs compared to other spread strategies. Furthermore, traders can use call or put options and take either long or short positions when implementing it.

The main advantage of it is that they allow traders to manage risk by taking multiple positions at different strikes and expiration dates. However, it is important to consider market volatility and timing when entering and exiting the spread, as it can also result in higher commission fees. Therefore, investing a smaller amount when entering a diagonal spread is also recommended to manage risk.

Diagonal spreads can be used by various traders, including options traders, hedgers, and speculative traders. Options traders use it to take advantage of time decay and volatility in the market. Hedgers can use it to reduce risk by taking multiple positions at different strikes and expiration dates. Finally, speculative traders may use it to profit from market movements, but it requires a good understanding of market conditions, volatility, and timing. In general, diagonal spreads can be used by traders with a moderate to high level of experience and risk tolerance.

The traders have to make certain adjustments while trading an options contract. A diagonal call spread is a popular options trading strategy. It involves buying a call option at a specific strike price and expiration date and selling another with a different strike price and expiration. The spread can be adjusted during the trade; for example, the short-call option can be bought and sold at a lower strike price closer to the stock price if the underlying stock price drops sharply before the first expiration.

Selling a put option with one strike price and one expiration and purchasing a second put option with a different strike price and expiration indicates the put diagonal spread strategy. During the deal, spreads can be changed to increase credit. For example, the short put option may be bought and sold at a higher strike price nearer the stock price if the underlying stock price rises sharply before the first expiration.

A simple example is buying the $10 option with an expiration date of 10 June 2023 and selling the $15 option with an expiration date of 10 January 2023. In this case, the trader bought an option with a longer expiration date and a lower strike price and sold the option simultaneously with a near-expiration date and a higher strike price.

Let us look at the graph for a better understanding:

The two strike prices are S-1 and S-2. 

S-1: Strike for short option

S-2: Strike for the long option

Although diagonal, calendar and vertical spreads are options spread, there is are differences between them. While the vertical spread allows traders to trade at different strike prices, the calendar spread focuses on having different delivery dates, and the former also performs differently. It is a mixture of the calendar and vertical spreads where they can buy and sell simultaneously at different strike prices and expiry dates. However, they all aim to hedge and adjust this strategy's risks.

This has been a guide to what is Diagonal Spread. We explain its comparison with calendar and vertical spreads, an example, a graph, and adjustments. You can learn more about finance from the following articles –

• Bull Put Spread
• Options Spread
• Bear Spread