Definition of Call Diagonal Spread

What does the term "call diagonal spread" mean? What is the definition of the term "call diagonal spread"?

When it comes to options trading, a "call diagonal spread" is when you simultaneously buy and sell a call option on the same underlying stock, though the calls have different strikes and expiry dates.

So, let's look at an example to illustrate this type of trade.

Let's say that you believe that a stock will trend higher into its earnings report, as it has a tendency to do this often. Let's say that this stock is Tesla.

Let's assume that Tesla is reporting earnings on Monday, May 12th.

You decide that you are going to buy an ATM call option that includes the week of earnings, and sell a slightly OTM call option that expires BEFORE earnings.

So, let's say that Tesla is currently trading at $670. You decide to enter a call diagonal spread that looks like this:

Buy 1 $670 call, May 16th expiry for $35
Sell 1 $700 call, May 9th expiry for $12

Ideally you want Tesla to trade up to $700 by the time that the first option expires on May 9th.

If this happens, your $670 call is worth significantly more (let's say it is now worth $50), while you get to keep the $12 in premium from the sale of the $700 call.

So, your cost basis for the trade originally was $23 per contract ($35-$12), and you end up making $50 per contract for a very nice gain.

In this trade, a key point to remember is that the call that you buy will retain a great deal of its value even if the stock falls, as there is the earnings volatility still priced into the options.

The $700 calls, on the other hand, DON'T include earnings, so you are hoping that they will expiry at $0 so that you can keep the premium.

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This is just one example of a call diagonal spread - there are a million different ways that you can play them.

A "Poor Man's Covered Call" is an example of a diagonal spread, as that involves buying a Far ITM call LEAP and writing short-term calls against the position.

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