Diagonal spread

Definition

A diagonal spread combines the calendar’s two expirations with the vertical’s two strikes: sell a near-dated option at one strike, buy a longer-dated option at a different strike, same type. It blends a directional tilt with a term-structure position — a calendar with delta, or a vertical with a time engine, depending on which way it is built.

How it works / structure

• Legs: −1 option at K_short, near expiry T1; +1 same-type option at K_long, later expiry T2. The long-call diagonal with a deep-ITM back leg is its own entry (strategy-pmcc).
• Cost/credit: usually a debit; deep-ITM back legs raise it, wider strike gaps and richer front premium reduce it. Risk is defined but NOT simply the debit when strikes differ — max loss depends on the strike gap and the back leg’s value at T1 (the engine computes it by scenario, not formula).
• Parameters (engine-executable): strike pair (back-leg delta, front-leg delta), expiry pair (T1/T2), term-state gate (vol_term_state), roll cadence for the front leg (mgmt-rolling — re-selling the front repeatedly against the standing back leg is the income variant), exits (mgmt-profit-target, mgmt-time-based-exit).
• Greeks profile: net delta from the strike offset, long back-month vega, positive theta near the short strike — three exposures at once, which is both the appeal and the failure surface.

When it applies

Directional theses with an income component (“drifts toward K_short over months”), stock-replacement overwriting (strategy-pmcc), and term/skew combinations (the two legs sit at different points on both surface axes — opt-term-structure, opt-volatility-skew). Requires the same event-calendar discipline as calendars.

Risk profile & failure modes

• Three-way attribution confusion: P&L mixes direction, term structure, and skew; without attribution the holder learns the wrong lesson from both wins and losses.
• Fast moves through the short strike: the front leg goes ITM and the position’s remaining value compresses toward the strike gap — the “income” variant can be forced into buying back the front at a loss repeatedly in a trend.
• Back-leg IV dependence: like calendars, the standing long leg’s value at each front expiry is an IV outcome, not a given.
• Assignment on the front leg (ms-expiration-exercise-assignment) — especially around dividends for call diagonals on dividend payers.

Evidence & limits

Mechanics are contract arithmetic (OCC/Cboe). No public study establishes diagonals as a class-level excess-return strategy; the platform treats each build as a parameterized thesis graded on replay, with attribution across the three exposures required in the result.

Falsifiable-thesis examples

Illustrations only, not signals:

• “X will finish the front cycle between K_short and K_short + 5% (front expires worthless, back retains value)” — falsified by the T1 outcome.
• “Re-selling monthly front calls against a 6-month back leg on Y will collect cumulative front premium exceeding 30% of the back leg’s cost over three cycles in replay” — falsified by the summed premiums.

Cross-references

• Parent structures: strategy-calendar-spread (same strikes), vertical spreads (same expiry)
• Named variant: strategy-pmcc; stock-based analogue: strategy-covered-call
• Surface axes: opt-term-structure, opt-volatility-skew
• Management: mgmt-rolling, mgmt-profit-target, mgmt-assignment-handling