Almost all options strategies are made up of what are known as spreads. Options Spreads are simply simultaneously buying and shorting different
options of the same type on the same underlying stock.
For example, Buying a $30 strike Call Option and simultaneously shorting its $33 strike
call option is a spread.
What are Diagonal Spreads | Types of Diagonal Spreads | Purpose of Diagonal Spreads | Advantages and Disadvantages
Diagonal Spreads, also known as time spreads or calendar spreads, are options spreads made up of options of the same underlying, same type but different expiration month AND strike prices. In fact, Diagonal Spreads can be considered a combination of Vertical Spreads and Horizontal Spreads. Diagonal Spreads are named Diagonal Spreads because the options that are involved in a Diagonal spread are stacked up diagonally on an options chain.
The example in the picture above is a Diagonal Calendar Call Spread on the AAPL buying its January $90 strike call options and shorting its February $100 strike call options. In fact, Diagonal Spreads are horizontal spreads with different strike prices.
Diagonal spread is simply a way of classifying options strategies using options of the same type but different strikes and month. Knowing or not knowing such classification does not actually affect your options trading in anyway. |
Like Horizontal Spreads, Diagonal Spreads also profit primarily from difference in
time decay between the longer term options
and the shorter term options, that is why Diagonal spreads are also known as Time Spreads or Calendar Spreads. On top of that,
Diagonal Spreads also has the directional advantage of Vertical Spreads, making it more popular than a horizontal spread.
There are 2 main types of Diagonal Spreads; Call Spreads and Put Spreads.
Call Diagonal Spreads are Diagonal Spreads utilizing call options. These are also more popularly known as
Calendar Call Spreads.
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The purpose for Diagonal Spreads is to profit from both time decay between the longer term options
and the shorter term
options as well as a directional move, thus combining the characteristics of horizontal spreads and vertical spreads.
Short term options have a higher
theta value and hence a higher rate of
time decay than longer term options. By making more in
time decay from the short term options than what is lost in the long term options, a positive return results. In this case,
the longer term options serve to eliminate the
margin requirement of shorting the short term options. If margin is not an issue,
one could simply short the near term options and take advantage of the full time decay without offsetting by the long term options.
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