A diagonal spread involves different strike prices and different expiration dates in which the options held long have a later maturity than the options held short. It is a conservative strategy with limited risk and considerable profit potential. If the spread is put on for a debit, that is the maximum risk and the possibility exists for writing options more than once against the same long leg. If the spread is put on for a credit, the maximum risk is the difference between strikes less the credit received. The advantage of owning options that are still "alive" after the shorter term options expire worthless, or at least closed out for a profit, means that the strategist then owns the remaining options at a substantially reduced cost, or possibly even for free. If the diagonal spread was originally put on for a credit and the short options expire worthless, the strategist makes money no matter what happens after that; sometimes a whole lot of money. It can be like hitting the lottery or winning the Kentucky Derby! Can you see why professional option traders love the diagonal spread? Especially, when put on for a credit? Heads they win big, tails they win small; but they still win, no matter what. It just doesn't get any better than that. |
