A long call diagonal spread is an options strategy involving the purchase of a longer-term call option and the sale of a shorter-term call option at a higher strike price. This approach combines elements of both vertical and calendar spreads, aiming to benefit from a moderate rise in the underlying asset's price, time decay of the short call, and potential increases in implied volatility.
In a long call diagonal spread, an investor:
Buys a call option with a closer-to-the-money strike price in a further-dated expiration.
Sells a call option with a further out-of-the-money strike price in a near-dated expiration.
This setup results in a net debit, as the long call typically costs more than the premium received from the short call. The strategy benefits when the underlying asset's price rises toward the short call's strike price near its expiration, allowing the spread to appreciate in value.
The profit and loss (P&L) diagram of a long call diagonal spread typically shows peak profitability when the underlying asset's price rises to the short call's strike price near its expiration. Calculating the exact maximum profit is challenging due to the differing expiration dates of the options involved. The maximum loss is limited to the net debit paid to establish the position, occurring if both options expire worthless.
To implement a long call diagonal spread, an investor needs:
Trading Approval: Authorization for options trading, specifically for strategies involving both buying and selling options.
Capital: Sufficient funds to cover the net debit incurred when establishing the spread.
Market Outlook: An expectation that the underlying asset's price will rise moderately toward the short call's strike price as its expiration approaches.
Assumptions:
Underlying Asset Price: $45 in February.
Long Call Option (June 50-strike) Premium: $5 debit.
Short Call Option (March 55-strike) Premium: $1 credit.
Net Debit (Cost): $5 (long call) - $1 (short call) = $4 debit ($400 total).
In this example, the trader pays a net debit of $4 to establish the long call diagonal spread. The strategy's profitability depends on the underlying asset's price movement and the timing of that movement relative to the options' expiration dates.
Executing a long call diagonal spread requires selecting the right strike price and expiration dates to maximize profit potential. Follow these steps to place the trade effectively:
Choose a stock or ETF where you expect a moderate upward move, rather than a sharp spike in price.
Ensure the asset has sufficient options liquidity to enable better fills and trade adjustments.
Buy a longer-term call option that is at-the-money (ATM) or slightly in-the-money (ITM) to benefit from directional movement.
Sell a near-term call option that is out-of-the-money (OTM) to generate income and offset the long call's cost.
The long call should expire in a further-dated cycle (e.g., 3-6 months away).
The short call should expire sooner (e.g., 1 month away).
This structure allows the short call to decay faster, benefiting the trade.
Enter the trade as a debit spread, meaning the cost of the long call will exceed the premium received from the short call.
Use a limit order to control execution price and avoid slippage.
Track time decay and implied volatility changes, as they significantly impact the trade's performance.
If the stock price approaches the short call's strike price near expiration, decide whether to roll the short call forward or let it expire worthless.
If the short call expires out of the money, you keep the premium and can sell another call.
If the short call is in the money, roll it forward or close the position to avoid assignment.
The long call remains active for further upside potential after the short call expires.
Short Call Benefits from Time Decay - The short call loses value quickly, which benefits the trader.
Long Call is Negatively Affected by Time Decay - If the stock price moves sideways, the long call may lose value faster than anticipated.
Higher IV Benefits the Strategy - If volatility rises, the long call gains value, increasing potential profits.
Lower IV Hurts the Strategy - If volatility drops, both options may decline in value, leading to losses.
If the short call is in the money, there is a risk of early assignment before expiration.
To avoid assignment, traders can roll the short call forward before expiration.
If the Stock Moves Too High: The short call may get assigned, requiring rolling the position or closing early.
If the Stock Moves Too Low: The long call loses value, but rolling the short call down may help recover some losses.
If IV Drops Significantly: A drop in IV can reduce the long call's value. If IV remains low, it may be best to exit early to cut losses.
| Factor | Long Call | Long Call Diagonal Spread |
|---|---|---|
| Market Bias | Strongly Bullish | Moderately Bullish |
| Maximum Profit | Unlimited if stock rises significantly | Limited to time decay and directional movement |
| Maximum Loss | 100% of premium paid | Net debit paid (lower than a long call) |
| Time Decay Impact | Negative (hurts the trade) | Partially positive (short call decay helps) |
| Implied Volatility Impact | A rise in IV benefits the long call | A rise in IV benefits the long call, but a drop in IV can hurt |
| Best Used When | Expecting a strong breakout | Expecting a gradual uptrend with controlled risk |
If capital is limited, as the spread reduces the premium cost.
If the stock is expected to trade near a key price level, allowing the short call to decay.
If implied volatility is expected to increase, benefiting the long call's value.
| Strategy | Best Used When... |
|---|---|
| Long Call Option | You expect a strong and immediate rise in the stock price. |
| Bull Call Spread | You expect a moderate rise but want a defined-risk alternative. |
| Short Put Option | You are bullish and want to generate income but can handle assignment risk. |
| Calendar Call Spread | You want a mix of bullish directional bias and time decay advantages. |
The long call diagonal spread is an advanced bullish strategy that capitalizes on time decay and implied volatility changes. It works best when:
However, because profits are capped and time decay can work against the long call, this strategy requires active trade management and is best suited for experienced options traders.
The long call diagonal spread is best for moderately bullish scenarios, benefiting from short call time decay.
The trade works best when the stock stays near the short call's strike price short-term, then continues higher.
Time decay and IV changes must be managed, as they significantly impact the strategy.
Rolling or adjusting the short call can help optimize performance if the stock moves too far in either direction.
Since this strategy involves trading both short-term and long-term options, it is ideal for traders comfortable with options pricing, volatility adjustments, and expiration management.