How do you set up a diagonal spread?

A call diagonal spread is a combination of a bear call credit spread and a call calendar spread. A call diagonal spread is created by selling-to-open (STO) a call option and buying-to-open (BTO) a call option at a higher strike price, with a later expiration date. Call diagonal spreads are typically opened for a credit, though a debit may be paid.

What are the benefits of using diagonal spreads?

The main purpose of diagonal spreads is essentially to profit from time decay. Short term options contracts generally experience a faster rate of time decay than long term options contracts, so by writing short term contracts and buying long term contracts you can potentially make a return from these differing rates of time decay.

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

The diagonal spread is very much like the calendar spread, where near term options are sold while long term options are bought to take advantage of the rapid time decay in options that are soon to expire. The main difference between the calendar spread and the diagonal spread lies in the near term outlook.

Are there any risks associated with diagonal spreads?

The maximum risk of any diagonal spread is limited to the initial debit you paid to enter the position. If AAPL falls hard, then your losses are capped at $200. One of the primary reasons you may want to close a diagonal spread is if you think you can earn enough premium from the resulting trade.