Diagonal Spread

Use call diagonal when moderately bullish - expecting price to rise toward your target. Use put diagonal when moderately bearish - expecting price to fall toward your target. Match the diagonal type to your directional view.

If price exceeds your short strike significantly, your profit may be capped or start declining. Options: (1) Close entire position to capture profit, (2) Roll short option to higher/lower strike to continue participating, (3) Close short option only and hold long option.

The back month option has more time value because it has longer until expiration. You're paying for that extra time value. The diagonal spread profits by having the front month decay faster than the back month, recovering your initial cost and more.

For a standard diagonal spread, your maximum loss is typically the net debit paid. However, if price moves far enough beyond your short strike and you hold to back month expiration, losses can be larger. Active management prevents this scenario.

A PMCC (Poor Man's Covered Call) IS a specific type of call diagonal. The PMCC uses a very long-dated (LEAPS), deep ITM call as the long leg, typically with 70-80 delta. Regular call diagonals might use closer-dated and/or ATM long calls. PMCC specifically tries to simulate covered call writing.

Roll when: Price is at or near short strike, thesis unchanged, and rolling provides credit or minimal cost. Close when: Thesis has changed, position is significantly profitable or at loss threshold, or you don't want to extend the trade. Key question: Would you enter this diagonal fresh?

You have three choices before expiration: (1) Close entire position - most common, safest approach, (2) Roll short option to next month - if you want to continue, (3) Let short expire, keep long - if short is worthless and you want the long position. Never hold through expiration without a plan.

For standard diagonals: 0.50-0.70 delta (ATM to slightly ITM) provides balanced exposure. For PMCC: 0.70-0.85 delta (deep ITM) mimics stock ownership. Lower delta (0.35-0.50) is cheaper but less directional. Choose based on how much directional exposure you want and budget.

Critical consideration: If earnings falls BETWEEN your expirations, IV dynamics become unpredictable. If front month expires BEFORE earnings and back month includes earnings, you may benefit from IV expansion. If front month includes earnings, beware of IV crush and large moves.

At 25-50% of max profit, seriously consider closing. Diagonals rarely achieve theoretical max profit. Factors favoring taking profits: significant profit achieved, approaching front month expiration, IV has expanded, or thesis confidence declining. Remember: a profit in hand is real.

Analyze: (1) Term structure slope - steeper contango favors diagonals, (2) Compare front vs back month IV - you want to sell elevated front IV or buy cheap back IV, (3) Monitor for term structure shifts during the trade, (4) Consider events that might distort term structure. Enter when multiple factors align favorably.

Double diagonal (call diagonal + put diagonal) when: expecting range-bound but uncertain of direction, want wider profit zone, comfortable managing multiple legs. Single diagonal when: have clear directional view, want simpler management, capital constraints. Double diagonals have more moving parts but offer flexibility.

Options: (1) Trade the underlying to neutralize delta, (2) Add another option position to offset delta, (3) Adjust short strike selection to modify delta exposure, (4) Use a second diagonal on the opposite side (creating double diagonal). For most retail traders, simply adjusting position size or accepting the delta exposure is more practical than active hedging.

Depends on expected move magnitude: 3-5% expected move = narrow width (50-75 points), 5-8% expected move = medium width (75-125 points), 8%+ expected move = wide width (125-200 points). Wider widths offer higher max profit but require larger moves. Match width to your price target and conviction level.

Inversion hurts diagonals - front month IV higher than back means you're selling cheap and buying expensive (relatively). Options: (1) Close if loss is acceptable, (2) Hold if you believe inversion is temporary, (3) Convert to vertical spread by rolling to same expiration (locks in current value), (4) Add positions that benefit from inversion. Prevention: check term structure before entry.