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DIAGONAL SPREADS

Core Concept: Sell near-term option at one strike, buy longer-term option at different strike to combine directional bias with time decay advantage.

Why It Matters​

Diagonal spreads blend calendar spread theta advantage with directional exposure. More flexible than pure calendars but more complex to manage.

When to Use​

✅ Use diagonal spreads when:

  • Moderately bullish/bearish with time
  • Want theta collection + directional edge
  • Rolling covered_call or cash_secured_put
  • Near-term IV elevated vs long-term

❌ Avoid when:

  • Strongly directional (use vertical spread instead)
  • Low IV differential between expirations
  • Beginner (start with verticals or calendars)
  • Don't understand combined risks

Strategy Mechanics​

Setup: Sell OTM near-term, buy ITM or ATM long-term (different strikes, different expirations)

Bull diagonal: Buy lower long-term call, sell higher short-term call
Bear diagonal: Buy higher long-term put, sell lower short-term put

Max profit: Complex (depends on final stock price and back-month value)
Max loss: Net debit (if stock moves far against position)

Trade-offs​

Pros: Directional profit + theta collection, rollable for continuous income, better than pure calendar for trending stocks
Cons: Complex adjustments, two expiration dates, profits less defined, requires active management

Diagonal spreads combine calendar_spreads time advantage with vertical_spreads directional bias.

Quick Reference​

Bull diagonal setup:

ComponentSelection
BuyATM/ITM call, 60-90 DTE
Sell5-10% OTM call, 30-45 DTE
DeltaNet +0.30 to +0.50 (bullish)
Cost$2-5 typical debit
GoalShort expires worthless, roll to next month

Bear diagonal setup:

  • Buy ATM/ITM put (60-90 DTE)
  • Sell 5-10% OTM put (30-45 DTE)
  • Net delta: -0.30 to -0.50

Management strategy:

  1. Front month expires worthless → Roll to next month
  2. Stock approaches short strike → Roll out and/or up
  3. Back month < 30 DTE → Take profit or roll to next cycle
  4. Target: 25-40% profit on debit

Examples​

EXAMPLE

Bull diagonal spread:

Stock: $100 (moderately bullish)

Buy: 100 Call (60 DTE) for $6.00
Sell: 105 Call (30 DTE) for $2.50
Net debit: $3.50 ($350)
Net delta: +0.40 (bullish exposure)

Scenario 1: Stock at $103 at front expiration

  • Short 105 call expires worthless: +$2.50
  • Long 100 call worth ~$5.50
  • Close for $5.50
  • Profit: $2.00 (57% gain)

Scenario 2: Stock at $108 (above short strike)

  • Short 105 call: -$3.00 intrinsic
  • Long 100 call: ~$9.00
  • Net: $6.00 value
  • Profit: $2.50 (71% gain)
  • Or roll short to 110 for additional credit

Scenario 3: Stock at $95

  • Both OTM but long has more time
  • Value: ~$2.50
  • Loss: $1.00 (29% loss)

Rolling strategy (PMCC - Poor Man's Covered Call):

Month 1:

  • Buy 100 Call (90 DTE) for $12.00
  • Sell 110 Call (30 DTE) for $3.00
  • Debit: $9.00

Day 30: Stock at $107, short expires worthless

  • Collected $3.00, long worth $11.00

Month 2:

  • Sell 112 Call (30 DTE) for $2.50
  • Total collected: $5.50
  • Cost basis: $6.50 ($12 - $5.50)

Month 3:

  • Sell 115 Call (30 DTE) for $2.00
  • Total collected: $7.50
  • Cost basis: $4.50

After 90 days: Turned $12 long call into $4.50 cost through rolling.

Diagonal vs vertical vs calendar:

Stock: $100, bullish view, 60 days

Vertical spread (bull call):

  • Buy 100 Call (60 DTE): $5.00
  • Sell 110 Call (60 DTE): $2.00
  • Cost: $3.00
  • Max profit: $7.00 (at $110+)
  • Risk/reward: 2.3:1

Calendar spread:

  • Buy 100 Call (60 DTE): $5.00
  • Sell 100 Call (30 DTE): $3.00
  • Cost: $2.00
  • Max profit: ~$1.50 (stock at $100 at 30d)
  • Neutral bias

Diagonal spread:

  • Buy 100 Call (60 DTE): $5.00
  • Sell 105 Call (30 DTE): $2.50
  • Cost: $2.50
  • Max profit: Variable ($2-4 range)
  • Bullish bias + theta collection

Diagonal = middle ground between directional and theta trade

PMCC (Poor Man's Covered Call) example:

Alternative to covered call:

Traditional covered call:

  • Buy 100 shares at $100 = $10,000
  • Sell monthly calls for $200/month
  • Income: 2.4% monthly on $10,000

PMCC:

  • Buy 80 Call (90 DTE, deep ITM) for $22.00 = $2,200
  • Sell 105 Call (30 DTE) for $2.00 monthly
  • Income: $200 on $2,000 capital (10% monthly)
  • Risk: If stock below $80, loss greater than covered call

Same income, 78% less capital, but higher risk in crashes. ```

References​