Diagonal Spread

Also called Bull (Bear) Leveraged Covered Call (Put)

• Long in-the-money (ITM) far-expiry call, strike price A

• Short out-of-the-money (OTM) short-term call, strike price B

• Generally, the underlying price will be closer to strike B than strike A

The long in the money call gives the right to buy at strike A. Selling the call at strike B obligates to sell at that strike price if assigned. The Bear version uses ITM far puts and OTM near puts.

This strategy acts like a covered call by using the far expiry call as a surrogate for owning the underlying. The premium received for selling the call represents a higher percentage of the initial investment than if buying the underlying outright. The potential return is leveraged and the downside exposure is reduced.