What is a Diagonal Spread?

Finance Articles | February 11, 2009

A diagonal spread is a great way to make monthly income from the stock market. It also allows you to profit from appreciation of the option itself.

A diagonal spread is a spread that allows you to produce a monthly income from the stock market and at the same time being able to profit from appreciation or depreciation in the stock.

Ok so how does it work? Simply put you buy an option that will not expire for many months. You also sell an option that will expire in the front month.

For example say you buy a call option 10 months out for $12. Then you sell a front month call with a higher strike price for $2. Initially you would be down $10, but if you kept selling front calls every month for the 10 months you could be profitable.

Let’s say that you sell a front month call every month for 10 months. You make $2 every month and sell a total of $20. That is great, considering you paid $12 and sold $20 worth of calls. That would give you a profit of $8 or 66% after just 10 months, if everything went well.

If the stock falls or if you are about to be called out you can easily buy back the option you have sold or sell the option you have bought in order to limit your losses.

The nice thing about diagonal spreads is that they allow you to profit as the stock increases too. Say the stock starts giving you a bullish signal 1 month and you think the stock will go higher, well you could always just decide to not sell a call that month.

This would leave you with a standard call option, which would increase as the price of the stock goes up, and would probably make you even more money than if you would have sold the option for that month.

Because it still is possible to lose money with a diagonal spread you should still use things such as stop losses, and risk management. They greatly increase your odds with any strategy.

To learn more about the diagonal spread visit http://www.stocks-simplified.com/Diagonal_Spread_Strategy.html

To learn more about the stock market visit http://www.stocks-simplified.com/

Article Tags: Diagonal Spread, Every Month

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ABOUT THE AUTHOR

When I was young I wanted to learn how to trade the stock market. So I traveled around the country listening to professional traders talk about how they are making money in the market. Now I understand how easy it is to make money in the stock market and started a site http://www.stocks-simplified.com/ to help others learn.