http://www.options-trading-education.com/4474/diagonal-spreads-explained/ Diagonal Spreads Explained There are an almost infinite number of ways to trade the markets but all share one common goal and that is to maximize profits with the minimum of losses. While there are lots of different techniques that can be employed to achieve this, many traders use similar methods to get results. Diagonal spreads are a way of trading the market that allows individuals to benefit from the natural progression of a price over a period of time, as well as covering their risk by essentially hedging their bets. Diagonal spreads are used in the options market on the same financial instrument but with a different strike price and varying lengths of time. The term, `diagonal` may be hard to understand without any prior knowledge of the options market, so it`s worth taking some time to first explain how a typical spread on the options market would look. There are two types of spread primarily. These are vertical and horizontal. The months would be seen along the horizontal listing while the strike prices would be seen vertically. Trading horizontally means using the same strike but in different months while a vertical spread involves the same month but different strikes. Horizontal spreads are also known as calendar spreads, for obvious reasons. Trading a diagonal spread means going both horizontally and vertically at the same time, trading different strike prices in different months. To use a diagonal spread usually means going in one direction for the first option and then taking the opposite direction for the second option expiry. This involves considerable skill because in order to profit, you need to identify an option that is likely to drop, consolidate and then climb or increase, plateau and then tail off. The desired direction depends on whether you have chosen to go short with your initial option and then long on your second trade, or vice versa. Experts suggest that the best targets for diagonal spreads are options that are likely to stagnate for several months before moving higher or lower. Having at least a 15% margin between purchased and sold options is also highly recommended. While it is essential to find an option that will remain steady for several months, a degree of volatility is also necessary in order to create the price fluctuation, which will provide the returns. In this market, trades are leveraged meaning that it is possible to maximize profits without having large amounts of free capital. With the two differing trades open, most brokers will only require a margin that correlates to the difference between the two values, making it even more accessible for investors. Using diagonal spreads takes some skill to ensure that you are adequately covered to prevent any losses if the price suddenly hikes up or down.