Diagonal Spread Options Strategy: Complete Guide
Master diagonal spreads—the hybrid strategy combining calendar and vertical spread advantages. Learn construction, rolling techniques, and how to profit from directional moves while collecting time decay.
What is a Diagonal Spread?
A diagonal spread is a hybrid options strategy that combines characteristics of both calendar spreads and vertical spreads:
- Different expirations like a calendar spread (short-term + long-term)
- Different strike prices like a vertical spread (creating directional bias)
- Same option type (both calls for bullish, both puts for bearish)
Diagonal Spread Structure
Sell: Near-term option at Strike A (15-45 days)
Buy: Longer-term option at Strike B (60-90 days)
Result: Net debit (pay to enter)
Key feature: Can roll short option multiple times before long expires
Bull Call Diagonal vs Bear Put Diagonal
Bull Call Diagonal (Bullish)
Sell: Near-term OTM call (higher strike)
Buy: Long-term ATM/ITM call (lower strike)
Best for: Moderately bullish, expect gradual rise
Example: Stock $100 → Sell $105 call (30d), Buy $100 call (75d)
Bear Put Diagonal (Bearish)
Sell: Near-term OTM put (lower strike)
Buy: Long-term ATM/ITM put (higher strike)
Best for: Moderately bearish, expect gradual decline
Example: Stock $100 → Sell $95 put (30d), Buy $100 put (75d)
Real Diagonal Spread Example
SPY Bull Call Diagonal (October 2023)
Initial Setup (October 1)
Stock Price: SPY = $430.50
Outlook: Bullish, expect slow grind to $450 over 2-3 months
Strategy: Bull call diagonal with multiple rolls
Trade Construction
- Buy: Dec 15 SPY $430 call @ $15.80 (75 DTE, long option)
- Sell: Nov 3 SPY $440 call @ $3.20 (33 DTE, short option)
- Net Debit: $12.60 = $1,260 cost/risk
Cycle 1 Outcome (Nov 3 - First Expiration)
SPY Price: $438.50 (up $8, +1.9%)
Short $440 call: Expired worthless ✓
Long $430 call: Worth $18.00 (42 DTE remaining)
Position Value: $18.00 (gain from $12.60 entry)
Roll #1 (Nov 6 - Sell New Short)
- SPY Price: $441.20
- Sell: Dec 1 SPY $450 call @ $2.80 (25 DTE)
- Premium Collected: $280 additional income
Cycle 2 Outcome (Dec 1 - Second Expiration)
SPY Price: $447.30
Short $450 call: Expired worthless ✓
Long $430 call: Worth $19.50 (14 DTE remaining)
Close Position (Dec 1)
Initial Cost: -$12.60 ($1,260)
Short premium (cycle 1): +$3.20 ($320)
Short premium (cycle 2): +$2.80 ($280)
Long option sold: +$19.50 ($1,950)
Total Profit: $1,290 on $1,260 risk
ROI: 102% in 60 days (2 rolls)
Why This Worked
- ✅ Stock moved in predicted direction ($430 → $447, +4%)
- ✅ Both short options expired worthless (collected full premium)
- ✅ Long option gained value from stock movement + time remaining
- ✅ Rolled successfully twice, generating $600 in short premium
Diagonal Spreads vs Other Strategies
| Feature | Diagonal Spread | Calendar Spread | Debit Spread |
|---|---|---|---|
| Direction | Directional (bull/bear) | Neutral | Directional |
| Strikes | Different | Same | Different |
| Expirations | Different | Different | Same |
| Rolling Potential | High (multiple rolls) | Moderate | None (same expiration) |
| Max Profit | Unlimited with rolls | Limited | Limited (spread width) |
| Complexity | High | Moderate | Low |
Strike Selection Strategy
Long Option (Back Month)
Strike Choice: ATM or slightly ITM
Delta: 0.50-0.70 (moderate to high)
Expiration: 60-120 days out
Purpose: Core position, provides delta and protects against adverse moves
Example: Stock at $100 → Buy $100 or $95 call (75 days)
Short Option (Front Month)
Strike Choice: OTM in direction of bias
Distance: 3-7% OTM from long strike
Delta: 0.20-0.35 (30-45% probability OTM)
Expiration: 15-45 days out
Purpose: Generate income, provide breakeven reduction
Example: Long $100 call → Sell $105 or $107 call (30 days)
Expiration Gap
Keep 30-60 day gap between short and long expirations. This allows 1-2 rolls of the short option before the long expires.
Example: Long 90 days + Short 30 days = Can roll short 2x (30 + 30) before long expires
Rolling the Short Option
The key advantage of diagonal spreads is the ability to roll the short option multiple times, generating continuous income:
When to Roll
Scenario 1: Short Expires Worthless (Ideal)
Condition: Stock stayed below short strike (calls) or above (puts)
Action: Let short expire, immediately sell new front-month option
Result: Keep full short premium, generate new income
Scenario 2: Short Has Small Value
Condition: Short worth < 20% of original premium
Action: Buy back short for small cost, sell new one further out
Result: Net credit on the roll
Scenario 3: Short In Trouble (ITM)
Condition: Stock moved past short strike
Action 1: Roll out AND up/down (adjust strike)
Action 2: Close entire position if past long strike
Risk: May cost debit to roll, reduces overall profit
Rolling Example
Original Trade: Long $100 call (90d), Short $105 call (30d), $8.00 debit
30 days later: Stock at $104, short $105 call expires worthless ✓
Roll: Sell new $108 call (30d) for $2.50 premium
60 days later: Stock at $107, short $108 call expires worthless ✓
Roll: Sell new $110 call (30d) for $1.80 premium
90 days later: Close long $100 call for $12.00
Profit: $12.00 + $2.50 + $1.80 - $8.00 = $8.30 profit (104% ROI)
Risk Management
Maximum Loss
Max Loss: Net debit paid to enter
Occurs when: Stock moves significantly against position OR IV collapses
Example: Paid $8.00 debit = $800 max risk per spread
When to Exit at a Loss
- 50% loss threshold: Close if position down 50% of initial debit
- Directional thesis broken: Major reversal, broken support/resistance
- Time running out: Less than 2 weeks until long expiration with no profit
- IV collapse: Significant drop in implied volatility hurting long option
Position Sizing
- Per position: 2-5% of portfolio maximum
- Total diagonal exposure: No more than 15% of portfolio
- Typical allocation: $800-2,000 per spread
- Diversification: Use different underlyings and expirations
Common Mistakes
❌ Selling Short Option Too Close to Long
Problem: Not enough room for stock to move profitably
Solution: Keep 3-7% gap between strikes
❌ Not Rolling When Profitable
Problem: Letting position sit idle after short expires worthless
Solution: Immediately roll to next cycle to continue generating income
❌ Rolling for Debit
Problem: Paying to roll the short option reduces overall profit
Solution: Only roll if receiving net credit or small debit (< 25% of premium)
❌ Using Too-Short Long Option
Problem: Not enough time to roll short option 2-3 times
Solution: Use 75-120 days for long option minimum
Tools & Resources
Strategy Analyzer
- Build custom diagonal spreads
- Visualize P&L across time
- Compare strike selections
- Simulate rolling scenarios
IV Scanner
- Find low IV candidates
- Track IV rank < 40
- Historical volatility data
- IV expansion potential
Greeks Dashboard
- Real-time position Greeks
- Delta, theta, vega tracking
- Time decay monitoring
- Roll scenario analysis
Frequently Asked Questions
How many times can I roll a diagonal spread?
You can roll as many times as your long option has remaining time. Typically 1-3 rolls before the long expires. Each roll generates additional income. Example: 90-day long option with 30-day shorts = 2-3 potential rolls.
What happens if the stock blows past my short strike?
If stock moves significantly past your short strike: 1) Your diagonal acts like a vertical spread with capped profit, 2) Long option protects you from loss, 3) You can roll short strike further out (may cost debit), or 4) Close entire position for partial profit. Maximum profit is still substantial due to long option value increase.
Can I use diagonal spreads in an IRA?
Yes! Diagonal spreads are defined-risk strategies allowed in most IRA accounts at Level 2 or 3 options approval. Check with your broker—they're treated similarly to calendar spreads and debit spreads.
What's the difference between a diagonal and a poor man's covered call?
They're essentially the same strategy with different names. "Poor man's covered call" is a bull call diagonal spread (long ITM call + short OTM call). It simulates a covered call using less capital by using a long call instead of owning 100 shares.
Should I close the long option when it has little time left?
Yes. With < 2 weeks until long expiration, either: 1) Close the entire position and take profits, or 2) Roll the long option out to a further expiration (but this increases cost/risk). Don't hold until the final week—theta decay accelerates.
Start Trading Diagonal Spreads
Use ApexVol's tools to build, analyze, and manage diagonal spreads with confidence. Real-time Greeks, rolling scenario analysis, and P&L tracking help you maximize income from this versatile strategy.