A diagonal spread is a stock options strategy where an investor buys and sells two different options positions within the same stock class at different strike prices and with different expiration dates to hedge risk. It involves buying and selling two calls and two puts simultaneously. The strategy can result in profits or losses, and the underlying stocks are within the same class.
A diagonal spread is a stock options strategy whereby an investor opts to buy and sell two different options positions within the same stock class at different strike prices and with different expiration dates. A diagonal spread, therefore, is based on buying and selling two calls, or buying rights, as well as buying and selling two puts, or selling rights, of the same options at the same time.
The term diagonal spread is unique to stock options. A stock option is the permission, granted by a signed contract, to the legal holder of one or more shares of stock from the company issuing the shares to purchase the company’s stock at a specific price specified in the option contract and within a certain period of time. Stock options either buy – in some cases earned – the rights to leverage a stock’s future dividends if the stock’s price rises, or risk that advantage if the price falls at the end of the contract’s expiration date.
A diagonal spread is designed to hedge the risk to the option holder through the simultaneous sale and purchase of several option rights for a higher or lower price, also known as the strike price, the results of which will be realized within a certain period of time which varies considerably, but does not exceed one year. Put simply, a diagonal spread is akin to simultaneously betting for and against both teams in the same match.
When initiating a diagonal spread, an investor will buy and sell calls and put up two different stock options at different strike prices. The strike price is the price of a share at the time the investor signs the option contract. If the strike price was higher on the contract expiration date, the expiration date and the investor bought a call, then said investor bought the option on the stock at a lower price and the term of the option expires with the investor who profits from it. Unfortunately, a diagonal spread can also have the opposite result.
Diagonal spreads involve several options, but the underlying stocks are within the same class, A or B. Class A shares are common stock, available to the public and carry 1 vote per share. Class B is commonly allocated 10 votes per share and is usually reserved for the owners/founders of the issuing company so they can retain control of the company.
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