238  •   The Intelligent Option Investor
Short Diagonal
RED
GREEN
Downside: Undervalued
Upside: Overvalued
Execute: Sell an ATM call option while buying one to cover at a 
higher price (short-call spread) and simultaneously buy 
an OTM put option (long put)
Risk: Sum of put’s strike price and net premium paid for call
Reward:  Amount equal to the put’s strike price minus any net 
premium paid for it 
Margin: Amount equal to spread between call options
The Gist
The diagram for a short diagonal is just the inverse of the long diagonal and, of 
course, looks very similar to the risk-return profile diagram for a short stock—
accepting upside exposure in return for gaining downside exposure. The gist 
of this strategy is simply the short-exposure equivalent to the long diagonal, so 
the comments about the long diagonal are applicable to this strategy as well. 
The one difference is that because you must spend money to cover the short 
call on the upside, the subsidy that the option sale leg provides to the option 
purchase leg is less than in the case of the long diagonal. Also, of course, a stock 
price cannot turn negative, so your profit upside is capped at an amount equal 
to the effective sell price. This investment also may be ratioed (e.g., by using 
one short-call spread to subsidize two long puts).