What Is A Diagonal Spread, And How Does It Work?

What Is A Diagonal Spread, And How Does It Work

A calendar spread with many separate strike prices is referred to as a diagonal spread. After taking a short and a long position in two options of the same sort but with different strike prices and expiration dates, an options strategy is created by exiting the position after the short and long positions have been taken. Depending on the approach's structure and the options used, this strategy might have a bullish or bearish bias.

How is a Diagonal Spread Constructed?

Since it combines two different types of spreads, it is referred to as a diagonal spread. This is because it combines a horizontal spread and a vertical spread with different expiry dates and strike prices.  A matrix of strike prices and expiry dates is shown, with each option separated into its own column of the matrix. The placements of each option on an options grid, as well as the spreads between them, are referred to by the terms vertical spreads, horizontal spreads, and diagonal spreads, respectively. Vertical spread strategies use options listed in the same vertical column with the same expiration dates. This makes it much simpler to identify which options are being used since they are all located in the same vertical column.

On the other hand, options using a horizontal spread have different expiration dates than options utilising the earlier technique, but they have the same strike price. Because of this, the possibilities are laid out in a horizontal fashion on a calendar. The options used in diagonal spreads are traded in a diagonal pattern on the quotation grid since the strike prices and expiration dates of the options used in diagonal spreads fluctuate.

Types of Diagonal Spreads

Since each option has two independent characteristics, the strike price and the expiry date, there are many different types of diagonal spreads. They may be bearish or bullish, short or long, and make forecasts using calls or puts.

Long diagonal spreads account for the vast bulk of diagonal spreads. To be lucrative, the holder must purchase the option with the more extended expiry date and sell the option with the shorter expiry date. In this circumstance, call diagonals are equally as successful as put diagonals. There is, of course, a demand for the opposite. A short spread requires the holder to buy the shorter expiry and sell the more prolonged expiration.

Wrapping Up

The simplest way to use a diagonal spread is to complete the trade when the shorter option expires. In reality, however, many traders "roll" their strategies by exchanging an expired call for an option with the same strike price but an expiry date as a longer option (or earlier).

You may make a lucrative trade by carefully timing your bids and picking the appropriate strike prices. If trading isn't your thing, you may try becoming an investor in upcoming IPOs. Whatever you select, keep a Demat and trading account. You cannot invest in the financial markets until you have one. You may open a demat account with Motilal Oswal in just a few minutes.


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