What is the difference between a calendar spread and a diagonal spread?

Diagonal spreads and calendar spreads share a similar characteristic in the sense that they both have long and short strikes in different expirations. A calendar spread’s long and short strikes share the same strike price, which makes it a cheaper trade on entry compared to a diagonal spread.

How do Diagonal spreads work?

With diagonal spreads, the combinations of strikes and expirations will vary, but a long diagonal spread is generally put on for a debit and a short diagonal spread is set up as a credit . Also, the simplest way to use a diagonal spread is to close the trade when the shorter option expires.

How much does a call diagonal spread cost?

In the example above, the call diagonal spread is 20 points wide, and the total entry cost for the trade is $18.30. The long option with 50dte is trading for $21, and the short option that expires in one day is trading for $1.97 and is made up of purely extrinsic value. In one day, all of that value will decay to $0.

What is a short option in a diagonal spread?

The short option in a diagonal spread works to hedge against the cost of the long option, and also against unfavorable moves, but the short option is only worth a fraction of the long option, so the hedge is only temporary.