Diagonal Spread
A diagonal spread is an options strategy that combines a longer-dated long option with a shorter-dated short option at a different strike price, creating a position that benefits from both time decay on the short leg and directional movement in the underlying.
A diagonal spread sits between a calendar spread (same strike, different expirations) and a vertical spread (same expiration, different strikes) on the options strategy spectrum. It involves different strikes and different expiration dates simultaneously — displayed diagonally on an options matrix, hence the name. The most common form is the long diagonal, where a trader buys a further out-in-time option and sells a nearer-term option at a strike closer to or above the current price.
For instance, a trader bullish on Amazon (AMZN) might buy a 90-day $180 call and sell a 30-day $185 call. The near-term sold call generates income from rapid time decay and partially offsets the cost of the longer-dated position. If the stock stays below $185 at the near-term expiration, the trader retains the premium and can roll the short call to the next month, continuing to collect income while the back-month call retains more of its time value.
Diagonals are valued for their flexibility. Unlike calendars, which are strictly neutral and centered on a single strike, diagonals can be constructed with a directional lean — typically bullish when using calls or bearish when using puts. The long back-month option provides significant upside participation if the underlying moves favorably, while the sold front-month option reduces the net cost basis over time through repeated rolling.
From an IV perspective, diagonals are net long vega: the longer-dated option has more sensitivity to implied volatility changes than the short-dated option. When IV is low and expected to rise, diagonals can appreciate significantly even before the underlying moves. This makes them popular in low-volatility regimes where traders expect both directional movement and a volatility expansion.
Poor man's covered call is a widely discussed diagonal variant where the long back-month call is deep in-the-money, serving as a surrogate for stock ownership. The deep-in-the-money call has a delta close to 1.00, mimicking the behavior of 100 shares of stock, but requires far less capital. Against this position, the trader sells near-term out-of-the-money calls just as they would in a standard covered call strategy, generating income without needing to own shares outright.