Diagonal Spread

A diagonal spread is an options position built from two options of the same type (both calls or both puts) on the same underlying stock, where the two options differ in both their expiration date and their strike price. That double difference is what makes it "diagonal" — if you laid the option chain out as a grid with strikes across the top and expiration dates down the side, a spread using the same strike but different expirations would run vertically (a calendar spread), and one using the same expiration but different strikes would run horizontally (a vertical spread). A diagonal spread moves in both directions on that grid at once.

In practice, a trader typically sells a shorter-dated option and buys a longer-dated option at a different strike, collecting some premium from the short leg to offset the cost of the long leg. The position profits from a combination of the underlying moving toward the strikes chosen and from time decay, since the option sold closer to expiration loses time value faster than the one bought further out. Because the two legs have different expirations, the position's behavior changes over time in a way a simple vertical spread's does not: once the near-dated option expires or is closed, the trader is left holding just the longer-dated option, effectively converting the diagonal into a single-leg position.

The nuance that trips up newcomers is that a diagonal spread isn't one fixed thing — it's a family. Depending on which strikes and expirations you pick, and whether you're using calls or puts, you can build a bullish diagonal, a bearish diagonal, or more complex versions like a diagonal butterfly. A well-known example, the "poor man's covered call," is really just a diagonal call spread: buying a long-dated, deep-in-the-money call to stand in for owning the stock, then selling short-dated calls against it repeatedly. Because pricing depends on two different expiration cycles with two different implied volatilities, diagonal spreads are also more sensitive to volatility shifts between near-term and far-term options than single-expiration spreads are.