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A diagonal spread is a calendar at different strikes — combining direction with time. Often run as a poor man's covered call, it gives you a theta tailwind without tying up the capital to own 100 shares.
Diagonal Spread
A calendar where the long leg and short leg are at different strikes — combining direction (the strike difference) with time (the expiration difference). Often used as a 'poor man's covered call.'
Payoff at expiration
Example legsGreeks
When to use it
Moderately directional with defined risk and theta tailwind. Common as a covered call substitute when you don't want to tie up the capital to own 100 shares.
Setup
Buy a longer-dated ITM option (the 'stock substitute'); sell a shorter-dated OTM option (the 'covered call'). Calls for bullish, puts for bearish.
Steps
- 1Pick a longer-dated (60–120 DTE) ITM option as your long leg.
- 2Pick a near-term (~30 DTE) OTM option as your short leg.
- 3Submit as a single combo at a limit debit.
- 4Roll the short leg at expiration for ongoing income.
Cost
Net debit. Max loss capped at the debit (plus any roll losses on the short leg).
Effect of price
Profitable up through the short strike. Above the short strike, gains slow and the short leg starts costing you.
Effect of time
Theta-positive — the short leg decays faster than the long leg.
Effect of volatility
Long vega — the long leg dominates.
Pros
- Capital-efficient covered call substitute.
- Defined risk.
- Theta-positive.
Cons
- Roll discipline required — manage the short leg every cycle.
- Long leg decay accelerates if spot moves below it.
- Sharp moves complicate adjustment.
Tips
- Keep the long leg deep enough ITM (~0.80 delta) to behave like stock.
- Roll the short leg to the next monthly when it hits 21 DTE or 50% profit.
- Avoid earnings — the short leg's gamma can blow up.
The math
P/L is asymmetric — capped on the upside (short strike caps), defined loss on the downside (long leg decay + lost premium).
Not investment advice.
