Skip to main content

Diagonal Spread

BTC is at 94,800 and you want to run a covered call strategy. Problem: buying 1 BTC costs 94,800. The premium from selling a single 14-day call might be 1,950. That's a 2% yield on nearly six figures of capital. There's a better way.

A diagonal spread uses different strikes and different expiries. It's a hybrid of a vertical spread (different strikes) and a calendar spread (different expiries). The most popular version (the "poor man.s covered call") costs 20% of the capital for 80% of the exposure.

💡

The poor man's covered call lets you run a covered call strategy on 95k BTC without holding 95k of BTC. A deep ITM LEAPS call captures 88% of the move for a fraction of the price.

What You Do (Poor Man's Covered Call)​

The SetupYou pay premium
Buy1 deep ITM call, far-term expiry (the "stock replacement")
Sell1 OTM call, near-term expiry (the "covered call")
Max Profit
Near short strike
Max Loss
Net debit
Capital Required
Much less than stock
Theta
Net positive (near term decays faster)

Worked Example​

BTC at $94,800. Buy the deep ITM $75k LEAPS call (90-day, delta 0.88) for $21,200. Sell the $98k 14-day call for $1,950.

Net debit: 19,250. Compare that to 94,800 for owning the underlying outright.

If BTC stays at 94,800 through the 14-day expiry, the short call expires worthless. You keep the 1,950 premium. Your LEAPS is still worth roughly 20,800. Roll the short call to the next 14-day cycle and collect another 1,800-2,100.

If BTC rallies to 98,000, the short call is ATM at expiry. Your LEAPS gained about 2,816 (delta 0.88 x 3,200 move). Combined with the 1,950 premium, that's 4,766 on 19,250 deployed. A 24.7% return on capital vs 5.4% if you'd owned spot and sold the same covered call.

If BTC drops to 87,000, you lose roughly 6,864 on the LEAPS (delta 0.88 x 7,800 decline) but keep the 1,950 premium. Net loss: 4,914. On spot, you'd have lost 7,800. The diagonal doesn't protect you from downside, but you've risked less capital.

How the P&L Works​

The deep ITM long call acts like stock (high delta, ~0.80-0.90) but costs a fraction of buying the underlying. The short near-term OTM call generates income against it, just like a covered call.

  1. Below long call strike. Worst case. Long call loses most value. Loss capped at net debit.
  2. Near the short call strike. Ideal. Short call expires worthless, long call retains significant value. Maximum P&L.
  3. Far above short call. Short call goes ITM, offsetting long call gains. P&L depends on the time value remaining in the long leg.

Explore the Payoff​

The chart below approximates the diagonal as a covered call (long stock + short call) since the deep ITM LEAPS behaves like stock. The actual P&L also depends on far-term IV changes.

Spot at Expiry$100k
$70k$130k
Short Call Premium$3k
$1k$8k
BE $97k$0+$8k-$27k$70kK $105k$130kSpot Price at ExpiryP&L
Settlement
$100k
P&L
+3.0k
Max Loss
-$27k
Max Gain
+$8k

When to Use​

  • You want covered call income but can't afford (or don't want to hold) 95k+ of BTC or ETH
  • You want capital efficiency. 19k tied up instead of 95k for similar exposure
  • You have a mildly bullish outlook through the near-term expiry
  • Far-term IV is relatively cheap compared to near-term (you're buying far, selling near)

Common Mistakes​

Common Mistakes
The mistakeBuying a far-term option that's not deep enough ITM. "The \$90k call is cheaper, I'll save money."
The realityAn ATM or slightly ITM LEAPS has too much extrinsic value. You're paying for time premium that decays against you on both legs. You need delta of at least 0.80 on the long leg -- deep ITM -- so it behaves like stock. The \$75k call at 0.88 delta costs more upfront but moves dollar-for-dollar with BTC.
The mistakeNot rolling the short leg in time. Letting it go to expiry at 2 DTE because "maybe it expires worthless."
The realityIf the short call goes ITM near expiry, your position becomes a locked spread with no ability to adjust. Roll the short call at 5-7 DTE when there's still time value to sell. Don't play chicken with gamma.
The mistakeIgnoring the term structure. Buying far-term options when far-term IV is at a premium.
The realityIf 90-day IV is 72% and 14-day IV is 58%, you're buying expensive vol and selling cheap vol. That's backwards. The diagonal works best when the term structure is flat or inverted -- near-term IV elevated relative to far-term.

Greeks at a Glance​

Greek
Sign
Plain English
Delta
+
Net long, similar to a covered call but lower delta
Gamma
Low
Both legs partially offset
Theta
+
Near-term short leg decays faster than far-term long leg
Vega
+
Long far-term vega dominates. Rising IV helps.

Related:

Last updated on