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The **diagonal spread** is one variation of option spread trading that has been used most effectively to adjust existing spread positions.

It is called by this name because unlike regular vertical spreads
where you go long one strike price and short another - the diagonal
spread includes the extra dimension of ** different expiration dates**.

If you think of expiration dates as the **horizontal** aspect of option spreads and the strike prices as the **vertical** aspect, then combining the two is what creates the "diagonal" effect - and hence the name.

This strategy uses the same *type* of option contract - i.e. all
calls or all puts. The most appropriate application is going short
(selling) the front month and long (buying) the later expiration month
in order to take advantage of option time decay, or *"theta"*.

Since the value in the **front** month options will erode at a **greater rate** than the later month options, this is where the
advantage lies.

Diagonal spreads can be adapted to both credit spreads and debit spreads.

If you are creating a diagonal **credit** spread, then since you are selling the front month expiration and buying the
later month, the greater time value in the later month premium will mean
you will *receive less credit* than you would from a regular vertical
credit spread.

In such cases, you should take into consideration the implied volatility in the **later** month options as well as the distance between the strike prices, as part of your strategy.

If your diagonal spread is entered with both strike prices
'out-of-the-money' the ideal scenario is that price action of the
underlying will trade closer to, *but won't breach*, the strike
price of the *sold* options by the time they expire.

If this happens, you will keep all the premium from the sold options but still retain a long position which is now closer to the money and comes with another month or more time value still remaining.

Depending on the difference between option expiration months and the length of time it has taken for the underlying to trade to this level, it is quite likely that the long position is also now more valuable and can be sold for maximum profit.

The above works particularly well with put options because increased implied volatility usually inflates put option prices when fear overtakes the market. So the back month long position has better value.

But if the price action of the underlying falls away from the closer short strike price, you simply get to keep the overall credit received when you entered the position.

A company or ETF's shares are currently trading at **$45** and you wish to construction a **call diagonal spread** position.

- Sell 10 XYZ $50
**January**call options for $5 - Buy 10 XYZ $55
**March**call options for $2

You receive an overall credit to your account of $3

You'll notice the __vertical__ aspect is a **$5 difference in strike
prices** and the __horizontal__ aspect is a* 2 month difference in expiration
dates*.

If the price of the underlying trades up to $50 at the front month expiration date, you get to keep the $3 credit you received.

At this time the later month $55 long call option will now be worth more, being closer to the money but with remaining time value (let's say $2.50) so you can choose to sell this for an overall profit of $5.50 times the number of shares covered by the option contracts.

You have risked $2 being the difference in strike prices ($5)
minus your initial credit ($3), to make $5.50. This scenario gives a
**good return on risk**.

The diagonal spread can be adapted to both credit and debit spreads, each with their own risk to reward ratio. You can adapt them to the following vertical spreads:

The Diagonal . . .

More comprehensive information about diagonal spreads, calendar
spreads and double calendar spreads, including how to "trade by the
numbers" using the option "greeks" can be obtained from a series of
downloadable videos obtainable from the **Options Trading Pro System**.

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