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How to Structure Diagonals

Options Jive

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

A Diagonal Spread is the combination of a Vertical Spread and a Calendar Spread. While it can have similar characteristics to a Covered Call, it's important to know how to structure these trades properly.

Diagonals can be used as a replacement for covered stock (covered call or covered put), but because there are two different expiration cycles used in the diagonal strategy, there is no known max profit . However, the width of the strikes can serve as a ballpark figure for possible profits. This was demonstrated in a table.

Another table showed a Diagonal Spread with a Debit that exceeded the width of the strikes. The table showed that although it had positive Deltas, if the stock explodes to the upside and the options trade at intrinsic value, there would be a negative profit. Structuring the trade at order entry to get paid if you're directionally right is important.

The debit in terms of the strike width will vary with the strikes and expiration selected. Our general target for debit spreads is 50% of the width. However, when you use deep in-the-money (ITM) strikes for a poor man’s covered call or put you could end up paying around 75% of the strike width.

Watch this segment of “Options Jive” with Tom Sosnoff and Tony Battista for the valuable takeaways and a better understanding of how to structure directional diagonal spreads.

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