Tim Olson
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34 lines
1.7 KiB
Markdown
34 lines
1.7 KiB
Markdown
---
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description: "A diagonal spread buying a deep ITM call at K1 with TTM T' and selling an OTM call at K2 with shorter TTM T < T', combining directional and time decay benefits."
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tags: [options, income, bullish, diagonal-spread]
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---
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# Diagonal Call Spread
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**Section**: 2.20 | **Asset Class**: Options | **Type**: Income
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## Overview
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The diagonal call spread consists of a long position in a deep ITM call option with strike K1 and TTM T', and a short position in an OTM call option with strike K2 and shorter TTM T < T' (K2 > K1). This is a net debit trade. The trader's outlook is bullish. At t = T let V be the value of the long call (expiring at T') assuming S_T = K2.
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## Construction
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- Buy 1 deep ITM call option at strike K1, TTM T' (longer expiry)
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- Sell 1 OTM call option at strike K2, TTM T < T' (shorter expiry, K2 > K1)
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Net debit: D
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## Payoff Profile
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At t = T (expiry of short call), let V = value of the long call (expiring at T') assuming S_T = K2:
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- P_max = V - D (if S_T = K2 at short expiry)
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- L_max = D (net debit paid)
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If S_stop-loss <= S_T <= K2, the trader can write another OTM call with TTM T1 < T'.
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## Key Conditions / Signals
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- Bullish outlook; expects stock to rise toward K2 by the short expiry
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- Low volatility environment after entry is ideal for maximizing time decay income
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- The deep ITM long call more closely mimics the underlying stock than an ATM call
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## Notes
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Similar to the calendar call spread but the deep ITM long call (unlike the close to ATM call in the calendar spread) more closely mimics the underlying stock, providing better protection against a sharp rise in the stock price. The trader can generate income by periodically selling OTM call options with shorter maturities.
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