Diagonal Spreads

Diagonal spreads are a group of option spreads which involve two options of the same type (two calls or two puts), on the same underlying, but with different strikes and expirations. They differ from calendar spreads (different expirations but same strike) and vertical spreads (same expiration and different strikes).

List of Diagonal Spreads

Diagonal Spread Example

A diagonal option spread can be constructed by buying an option and simultaneously selling another option on the same underlying, of the same type (call/put), and with different expiration and different strike.

For example, we can buy a 30 strike call option expiring in June and simultaneously sell a 35 strike call option expiring in April.

Long vs. Short Diagonal Spreads

A diagonal spread is long if it is long the option with longer time to expiration and short the option with shorter time to expiration. The above example (long June, short April) is a long diagonal spread.

On the contrary, a short diagonal spread is short the longer expiration option and long the shorter expiration option. An example would be the inverse of the above (short June, long April).

Order of Strikes in Diagonal Spreads

Compared to calendar spreads (where the two options also have different expirations, but same strike), diagonal spreads provide far more possible combinations due to the added variable of different strikes. The resulting exposure (to underlying price direction, volatility, time, and other factors) depends on the particular combination – diagonal spreads can be bullish or bearish, and they can be short or long volatility.

Generally, there are four basic kinds of call diagonal spreads:

  • Long longer expiration lower strike + short shorter expiration higher strike
  • Long longer expiration higher strike + short shorter expiration lower strike
  • Short longer expiration lower strike + long shorter expiration higher strike
  • Short longer expiration higher strike + long shorter expiration lower strike

Similarly, there are four possible types of put diagonal spreads.

Expiration and Strike Distance

In addition to the four basic types above, the resulting exposures are also affected by the particular strikes and expirations selected – mainly their distances.

For example, a spread of September 50 strike call and March 55 strike call (similar strikes but big difference in expirations) will behave very differently from a spread of September 50 strike and August 65 strike (similar expirations but strikes wide apart), although both are the same type.

Generally, a diagonal spread with expirations very close to one another (such as March and April) but strikes wide apart will behave more like a vertical spread. Conversely, a diagonal spread with similar strikes but big difference in expiration dates will be more like a calendar spread.

That said, even a very small difference in strikes or expirations can have significant effect on the resulting exposures, so more like a calendar spread does not mean exactly like.

With diagonal spreads, there are endless possibilities and it is hard to make generalizations. It is essential to understand the exposures of the particular position with its specific expiration and strike combinations (you can use the Option Strategy Simulator for that).

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