A diagonal spread is two options. One long dated, one short dated. Two different strikes. You buy the long expiration. You sell the short expiration against it.
The reason traders run a diagonal instead of a straight long call: the short option you sold pays for part of the long option. Lower debit. Lower break even. Same direction bias.
Bullish diagonal on something I want to own for the next two or three months. Buy a deep in the money call sixty to ninety days out. Sell a slightly out of the money call seven to fourteen days out against it.
The long call captures the move. The short call drips theta into my account every week. When the short call expires worthless or I close it cheap, I sell another one.
Tight strikes make the position act like a vertical. You lose the time component. Spread them out.
The short call is the moving piece. Close it at fifty percent of credit collected. Roll to the next week. Keep collecting.
If price runs through your short strike fast, you have decisions. Roll the short up and out. Or close the entire spread for a profit and reset.
If price drops hard, the long call loses value too. The short call expires worthless and you collect that. Then you have to decide if you still believe in the trade. If yes, sell another short call. If no, close the long for whatever value remains.
Capital. A hundred shares of a $200 stock is $20,000. A diagonal spread on the same stock might cost $1,500 net debit. Same upside exposure. Smaller account hit. The trade off is you have an expiration date on your thesis. Stock has no expiration.
chartmaster3000
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