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+Chapter 14: Diagonalizing a Spread 231 
+bull spread would be similar except that one would buy a longer-tenn call at the lower 
+strike and would sell a near-tenn call at the higher strike. The number of calls long 
+and short would still be the same. By diagonalizing the spread, the position is hedged 
+somewhat on the downside in case the stock does not advance by near-term expira­
+tion. Moreover, once the near-term option expires, the spread can often be reestab­
+lished by selling the call with the next maturity. 
+Example: The following prices exist: 
+Strike April Ju~ October Stock Price 
+XYZ 30 3 4 5 32 
+XYZ 35 11/2 2 32 
+A vertical bull spread could be established in any of the expiration series by buying 
+the call with 30 strike and selling the call with 35 strike. A diagonal bull spread would 
+consist of buying the July 30 or October 30 and selling the April 35. To compare a 
+vertical bull spread with a diagonal spread, the following two spreads will be used: 
+Vertical bull spread: buy the April 30 call, sell the April 35 - 2 debit 
+Diagonal bull spread: buy the July 30 call, sell the April 35 3 debit 
+The vertical bull spread has a 3-point potential profit if XYZ is above 35 at April expi­
+ration. The maximum risk in the normal bull spread is 2 points (the original debit) if 
+XYZ is anywhere below 30 at April expiration. By diagonalizing the spread, the strate­
+gist lowers his potential profit slightly at April expiration, but also lowers the proba­
+bility of losing 2 points in the position. Table 14-1 compares the two types of spreads 
+at April expiration. The price of the July 30 call is estimated in order to derive the 
+estimated profits or losses from the diagonal bull spread at that time. If the underly­
+ing stock drops too far - to 20, for example - both spreads will experience nearly a 
+total loss at April expiration. However, the diagonal spread will not lose its entire 
+value if XYZ is much above 24 at expiration, according to Table 14-1. The diagonal 
+spread actually has a smaller dollar loss than the normal spread between 27 and 32 
+at expiration, despite the fact that the diagonal spread was more expensive to estab­
+lish. On a percentage basis, the diagonal spread has an even larger advantage in this 
+range. If the stock rallies aboye 35 by expiration, the normal spread will provide a 
+larger profit. There is an interesting characteristic of the diagonal spread that is 
+shown in Table 14-1. If the stock advances substantially and all the calls come to par­
+ity, the profit on the diagonal spread is limited to 2 points. However, if the stock is 
+near 35 at April expiration, the long call will have some time premium in it and the