A short diagonal spread with calls is an options trading strategy with two parts. The trader sells a call with a distant expiration date and purchases a call with a higher strike price and closer expiration date. The goal is to profit from bearish movement of the underlying stock while limiting risk in case the stock price goes up. The trade is set up for a net credit or small debit and has both limited profit potential and limited risk. Ideally the stock price falls below the strike price of the short call which results in maximum profit. The worst case scenario is when the stock closes at the strike price of the long call at expiration.
What Is a Call Spread?
A call spread is any options strategy in which the trader buys and sells equal number of call options. Depending on the setup the strategy can be profitable in bull, bear, or neutral markets. A common approach is a vertical call spread in which the expiration dates are all the same but the strike prices vary. A diagonal call spread is set up with different strike prices and expiration dates. A calendar call spread has calls with the same strike price but different expiration dates. The short diagonal spread with calls has different strike prices and expiration dates and is used when the trader expects bearish price action.
How Do You Calculate a Short Diagonal Spread With Calls?
Because this trade is set up by selling a distant call with a lower strike price and buying a near call with a higher strike price the trade starts with a profit. If the stock moves below and stays below the strike price of the call that you sold you will make your maximum profit. The trade loses value when the stock price moves toward the strike price of the call that you purchased. You will lose money on the short call and may have the option exercised. This trade is best used when you can relatively certain that the stock will fall in price.
Pros and Cons of a Short Diagonal Spread With Calls
As with many option strategies, this one has limited risk and limited profit potential. Thus the good part of this trade is that it will make money when the stock price falls and has limited loss potential if the stock price lands on the strike price of the long call at expiration. But, if your assessment is wrong, this will not be a profitable trade. The loss will not be great but if you are not skilled at picking stocks to trade and predicting price movement, it could routinely result in losses. As with most option strategies, learning from the pros at Top Gun Options will help you set up the trades most likely to succeed and those where your losses, when they occur, will be manageable.
Options Trading With Top Gun Options
There are many possible options strategies. Learning how to choose options trades and strategies is basic to making money trading options. In general, options trading strategies for beginners should be easy to understand and easy to set up. An exception would be when you work with Top Gun Options and receive trade briefs from professional options traders. In this case you will have the benefit of years of trading experience and daily close attention to the market. In this case, you will be able to set up and profit from advanced trading strategies before you would normally have developed those skills yourself. Watch our Sitreps (situation reports) to get a sense of how we trade options and what you can learn from Top Gun Options.