Definition
The term diagonal spread refers to a strategy that involves the simultaneous purchase and writing of two options of the same type with different strike prices and expiration dates. Diagonal spreads also involve the same underlying asset.
Explanation
When executing a diagonal spread, the investor assumes both a long and short position in options of the same type (calls or puts). Each option has the same underlying security, but different strike prices and expiration dates. For example, the writing of a May $40 call and the purchase of a July $35 call would be a diagonal spread.
Generally, diagonal spreads take two forms:
Diagonal Call Spreads: if the investor is bullish on the underlying asset, they can use a diagonal bull spread to profit from the asset's increase in value. A diagonal call spread involves the writing of a higher strike price call option with a near-term expiration date and the simultaneous purchase of a lower strike price call option with a longer-term expiration date.
Diagonal Put Spread: if the investor is bearish on the underlying asset, they can use a diagonal bull spread to profit from the asset's decrease in value. A diagonal put spread involves the writing of a lower strike price put option with a near-term expiration date and the simultaneous purchase of a higher strike price put option with a longer-term expiration date
Related Terms
The term equivalent strategy refers to two positions that share the same risk and reward profile. When two traders assume different, but equivalent strategies, they will share the same payoff.
Moneyzine EditorJanuary 17th, 2024
The term equity option refers to a call or put involving an individual common stock or exchange traded fund (ETF). Equity options are considered equity derivatives and are the most common type of this contract.Moneyzine EditorJanuary 17th, 2024
The term early exercise refers to a feature of American options that permit the holder to exercise the option prior to its expiration date. While most index options are of the European-style, options involving equities are typically of the American-style.Moneyzine EditorJanuary 16th, 2024
The term derivative refers to a financial contract that derives a portion of its value and characteristics from an underlying asset. Derivatives have no value other than the expected future price movements of the underlying asset.Moneyzine EditorJanuary 16th, 2024
