What You Need To Know About Diagonal Trades

What You Need To Know About Diagonal Trades

What You Need To Know About Diagonal Trades


“Diagonal spreads” is a name that a lot of us have heard in the past and might not be sure as to what it essentially is. Diagonal spreads are a trading strategy used to buy and sell two different options of the same type. We can either put or call them at different strike prices and then in different expiration cycles. Essentially, these two options are the same but they are available at different prices (strike prices and expiration cycles), which makes all the difference and this is where you cash on.


The trick in diagonal spreads is that the long diagonal spreads are the ones that should be traded the most. A trader will buy an option with more days to its expiry and then sell the option with fewer days left to its expiry. Therefore, long diagonal spreads will be able to trade for a net debit or credit and it depends on which strikes does the trader choose to buy or sell.


Let’s take the example of Apple, AAPL in diagonal call spread. Say we have two options, $95/$100. We are short the 100 call and it has 25 days to its expiry and the long 95 call has 60 days to its expiry. Therefore, the long 95 call will hedge the short 100 call and it will provide the traders with a positive outlook. If the trader had brought this at 105 calls with 60 days left in its expiry, it would still be hedging the short 100 call but the overall impact of the diagonal would be negative delta.


The benefits of the diagonal spread lies in the possible profits that can be made with the long back month option that stands to gain.


Once we have established that diagonal spreads can help in maximizing gains, we then move to the topic of trading long diagonal spreads.

What To Do With Long Diagonal Spreads?


The best-case scenario with long diagonal spreads it to buy a long diagonal spread with a short option expire and an expansion in IV (implied volatility) in order to increase the price that is there at the remaining long option.


On the other hand, when the short option reaches expiry, we keep the entire credit received for selling the option, which will lower the cost basis of the long option we have. Even if the volatility expands near the expiration date, its extrinsic value (of the long option) will also increase in worth and it will maximize the total trade profit. Long diagonals are also long Vega and therefore, they benefit when the IV increases.


Diagonal spreads work around the difference in strike prices and expiration dates. This difference is what makes the difference in increasing the worth of your trades.

Benefits Of Diagonal Spreads


As mentioned earlier, diagonal spreads are all about choosing two different options with different expiry dates and then choosing to sell one of these options depending on its day to expiry to achieve prompt results.


The thing in the case of diagonal spreads is that its working mechanism is simple and once you get the gist of it, it is probably one of the easiest ways to minimize your losses and maximize your gains.

Spread Your Risks


First things first, diagonal spreads allow you to spread your risks wisely. See, you will have two options when we are trading with these spreads. Therefore, when we choose these two options, we are going to make profits based on date to expiry of the other. It gives users the option and ability to diversify, to hold and to have much more authority in their hands because they can choose whichever path they want to maximize their returns.


Also, when your money is directed in two baskets, as in the case of diagonal spreads, then you are better able to diversify your risk. If one thing collapses, you will know that your money or funds are not directed in one option.

Greater Authority


Diagonal spreads are one of those trade options that let you get greater authority as far as your trades are concerned. These options give you greater control because your assets are spread over two different options and then it gives you the choice to pick your choice of investment and then choose which one to sell first and which one to keep.


There is a lot of control for the trader as far as diagonal spreads are concerned, which make them a top choice especially for those who want higher control and authority over their trading decisions.

Easier To Sell-Easier To Make Profits With


Diagonal spreads are not one of those options that you have to be strategic with as there isn’t much to think about in the first place. These options are very easy to sell and you can also make quick profits with them, depending on how you choose between them and how you go about them. They are easy to handle as well, once you know what you have to do with them and then they give you a greater chance and opportunity to make your trades and make good effective money as well.


Diagonal spreads also do not act that volatile if the times are changing or the times become volatile. They are attractive to investors because they give them the option of choosing between two options and ensuring their trades take place in such a way that they maximize returns.


Diagonal spreads can be a little tricky if you do not understand how to or where to go about them but once you understand how they operate, they are probably one of the most flexible options you can explore as far as trading is concerned.


Most of the profits on diagonal spreads are made if you choose to sell them and you can only sell them if you buy them in the first place and choose your pick wisely.


Diagonal spreads are rising in popularity for they can be extremely beneficial for the trader. However, by knowing a few things about them beforehand, you can be more careful about how you trade them and then, how to make most money from them.