Diagonal Spread — Options Strategy

A diagonal spread combines elements of both a calendar spread and a vertical spread by using different strikes AND different expirations. The most common form is a 'poor man's covered call': buy a long-dated, in-the-money call (typically a LEAPS option) and sell a shorter-dated, out-of-the-money call against it—approximating the payoff of a covered call position but requiring significantly less capital.

The diagonal spread allows you to sell short-dated premium repeatedly against a long-dated option, with each cycle reducing your net cost basis in the long option. Unlike a standard calendar spread, the different strikes create a directional component—the position benefits from moderate upside in the stock while the sold front-month call generates income.

The LEAPS diagonal (poor man's covered call) is particularly appealing because a deep ITM LEAPS call has a delta close to 1.0 and behaves nearly identically to owning shares—but at a fraction of the capital. If a stock trades at $150, you might buy a $100-strike LEAPS call for $60 (instead of spending $15,000 on 100 shares) and sell monthly $155 calls for $2 each. Each monthly sale reduces your cost basis and generates income, just like a traditional covered call.

The key risk in diagonal spreads is the stock making a large move against the position. If the stock declines significantly, the long LEAPS loses value faster than the short call gains, producing a net loss. If the stock rallies past the short call strike quickly, the position is 'called away' in the sense that the short call becomes deeply ITM and must be rolled or closed.

Strike and expiration selection in diagonals involves a trade-off between leverage (deeper ITM long call for more delta exposure) and cost efficiency (the deeper ITM call is more expensive). Most diagonal spread traders target a delta of 0.70-0.85 on the long LEAPS call and sell front-month calls at a delta of 0.25-0.35, leaving the underlying room to move while collecting meaningful premium.