Diagonal Spread

Bull diagonal (PMCC — Poor Man's Covered Call): Buy a long-dated deep ITM call, sell a short-dated OTM call. Simulates a covered call position with less capital. Profits from time decay on the short call and upward movement of the underlying.

Bear diagonal (Poor Man's Covered Put): Buy a long-dated deep ITM put, sell a short-dated OTM put. Profits from time decay and downward stock movement. Less common because most traders prefer bear put spreads for bearish plays.

Call diagonal (neutral-bullish): Buy a longer-dated call at one strike, sell a shorter-dated call at a higher strike. Profits from the short call decaying faster while the long call retains value.

Put diagonal (neutral-bearish): Mirror of the call diagonal using puts.

Double diagonal: Combines a call diagonal and a put diagonal — similar to a double calendar but with different strikes on each side. Creates a wider profit zone and captures theta from both sides. Best in range-bound, moderate-IV environments.

The PMCC is the most widely traded diagonal spread because it replicates covered call economics at a fraction of the capital.

Setup: Buy a LEAPS call (6-24 months expiration) with 70-85 delta (deep in-the-money). Sell monthly calls at 20-30 delta (out-of-the-money) against it.

Capital comparison: A covered call on a $200 stock requires $20,000 for 100 shares. A PMCC might require $5,000-$7,000 for the LEAPS. The capital efficiency is 3-4x better.

Monthly income: Sell a new short call each month (or every 30-45 days) when the prior one expires. Each sale generates $100-$400 in premium on a typical large-cap stock, providing a steady income stream.

Risk: If the stock drops significantly, the LEAPS loses value and may not be worth rolling the short calls against. The position can also lose money if the stock rallies sharply above the short call and the LEAPS does not fully offset the assignment.

Key rule: The net debit of the PMCC should be less than the spread width (distance between LEAPS strike and short call strike). Otherwise, a large rally above the short call can result in a loss even though the trade is directionally correct.

Rolling the short leg: When the short option nears expiration or is in danger of being breached, roll it to a later expiration (and potentially a higher strike for calls, lower for puts). This collects additional premium and extends the trade.

Profit target: Close the entire diagonal at 25-50% of maximum theoretical profit. Diagonals have complex risk profiles that change as the short leg approaches expiration.

Stock rallies through short strike: This is the most common management challenge. You can: (1) roll the short call up and out, (2) close the entire position for a profit, or (3) accept assignment and buy the long call to cover. Option 1 is usually best if you remain bullish.

Stock declines: If the stock drops and the LEAPS delta falls below 60, consider closing the position to avoid further losses. The LEAPS becomes less responsive to a recovery, reducing the value of selling further short calls.

Avoid holding through ex-dividend dates: Deep ITM short calls can be assigned early on the day before a dividend. Close or roll the short leg before ex-dividend to avoid unexpected assignment.