Using Diagonal Spreads as a Long-Term Investment Strategy

Using Diagonal Spreads as a Long-Term Investment Strategy

If you are just beginning with doing investments, you might feel a bit overwhelmed. There are so many strategies out there. It can be difficult to differentiate between all of them, but if you are interested in trading options, then one strategy in particular that you should thoroughly investigate would be Diagonal Spreads. This is not only an excellent long-term investment, but it also is an excellent way to ensure monthly cash-flow as well. Here is some more information about this fascinating investment strategy:

What Are Diagonal Option Spreads?

According to tastytrade, a diagonal spread “can be characterized by simply placing a call or put option for a time way off in the distance, yet at the same time selling a call and put order that has been placed with a more recent date in mind to reduce the cost basis.” Diagonal Spreads usually come in two different types: the long put diagonal version and the long call diagonal type. When an investor wants to do a long put diagonal investment, they will normally purchase that is further out in the future, yet at the same time they will sell a near term with an OTM strike so that the costs are reduced. On the other hand, there are times where an investor may want to engage in a long call diagonal investment. In this case, the investor would purchase a call far into the future, yet at the same time they would sell a near term with an OTM strike in order to yet again reduce that cost basis. This is more of a bullish investment, and this position will generally benefit from increases in implied volatility. 

How To Use Diagonal Spreads as a Long-Term Investing Strategy  

Of course, this all begs the question: how do you go about doing this? Well, yet again, it’s really simple: all you do is simply purchase an expire that isn’t going to expire for many months, but at the same time you are going to sell options that will expire much sooner. You do this to go against your long-term option and to get exposure in different contracted months and different strike prices. What you are essentially doing is to choose both a “leg” that is in the “back month” and a “leg” that is in the “front month.” Of course, if you are going to fully understand this option, you will need to have a full understanding of the concept of a differential time decay. Additionally, you should be aware that a diagonal spread has to have two possible strike combinations and they will need to be the same. 

While you’re at it you probably should understand where this strategy gets its name in the first place. It is called “diagonal” simply because of the fact that you will first purchase a horizontal spread and get a vertical spread to offset any potential losses. Although one small disadvantage in this strategy is that you only have a limited upside profit potential, the beauty of this strategy is that you will also have limited risk as well. It is definitely a great way for you to make an impact in the options market. 

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