Diagonals
Definition : A diagonal spread is an option strategy that involves buying one
option and selling another option with a different strike price and with a
different expiration date. Diagonals are another strategy in the time spread
family.
Diagonals enable a trader to exploit opportunities similar to those
exploited by a calendar spread, but because the options in a diagonal spread
have two different strike prices, the trade is more focused on delta. The
name diagonal comes from the fact that the spread is a combination of a
horizontal spread (two different months) and a vertical spread (two different
strikes).
Say it’s 22 days until January expiration and 50 days until February
expiration. Apple Inc. (AAPL) is trading at $405.10. Apple has been in an
uptrend heading toward the peak of its six-month range, which is around
$420. A trader, John, believes that it will continue to rise and hit $420 again
by February expiration. Historical volatility is 28 percent. The February 400
calls are offered at a 32 implied volatility and the January 420 calls are bid
on a 29 implied volatility. John executes the following diagonal:
Exhibit 11.11 shows the analytics for this trade.
EXHIBIT 11.11 Apple January–February 400–420 call diagonal.