The diagonal spread is an option spread strategy that involves the simultaneous purchase and sale of equal number of options of the same class, same underlying security with different strike prices and different expiration months.
The diagonal spread is very much like the calendar spread, where near term options are sold while long term options are bought to take advantage of the rapid time decay in options that are soon to expire.
The main difference between the calendar spread and the diagonal spread lies in the near term outlook. The employer of the diagonal spread has a near term outlook that is slightly more bullish or bearish.
If the option trader's near term outlook is mildly bullish, he can implement a diagonal bull spread by writing higher strike near-month calls against lower strike far-month calls.
If the option trader's near term outlook is mildly bearish, he can employ a diagonal bear spread by writing lower strike near-month puts against higher strike far-month puts.
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