A long call diagonal spread can be viewed as a vertical call spread where the long call ( that is set up in a distant month ) is paid for by multiple sequential short calls that are set up in a proximate month.  

You would set up this strategy for a a bullish market environment where you feel that the stock will rise but not rise dramatically.  

The long call diagonal spread is set up for a debit.  Make sure that the intrinsic value of the long strike is similar to the intrinsic value of the short strike.  Do not set up the debit for more than 75% of the strike width of the strikes.  

A bullish long call diagonal spread is set up by

• Buy a distant month ITM call at a lower strike price
• Sell a proximate month OTM call at a higher strike price
• total debit paid should be no more than 75% of the strike width
• The intrinsic value of the long strike should approximate the short strike.

• Buy a distant OTM call at a higher strike price if you have an reasonable expectation of how far up the stock might go in a given time period.
• This will lower the cost of the OTM call
• Note that distant ITM options can be less expensive than buying long stock and their risk is limited to the price of the call. 
• This strategy would be similar to establishing a covered call.

This option is typically closed when the short option expires. However, it is also common close the short option only to sell another short option for more premium either at the same strike price or a different strike price depending on the support and resistance expectations.

The setup of a diagonal spread is very important. If we have a bad setup, we can actually set ourselves up to lose money if the trade moves in our direction too fast. 

To ensure we have a good setup, we check the extrinsic value of our longer dated ITM option. Once we figure that value, we ensure that the near term option we sell is equal to or greater than that amount. 

The deeper ITM our long option is, the easier this setup is to obtain. We also ensure that the total debit paid is not more than 75% of the width of the strikes.

We never route diagonal spreads in volatility instruments. Each expiration acts as its own underlying, so our max loss is not defined. 

“Rolling” is an important concept in trading, particularly when it comes to calendars and diagonals. The roll is when you buy to close the near-term short option and sell to open a further-term option at the same strike price, while leaving the long option alone. Because the near-term option is cheaper than the further-term option, that transaction generates a credit. The idea is that as you keep rolling the short option from one expiration to the next, you generate additional credits whether it’s done in a covered call or a diagonal.

The best stock movement scenario is for the stock to moves quickly in your favor and past the break even soon after establishing the option.

Long calls are strongly affected by theta time value.  It loses value with time and the losses accelerate as you approach expiration.  

Long calls are also positively affected by volatility.  The higher the volatility, the more the option is worth.  Volatility obviously increases if the stock moves quickly in either direction.  

If the stock moves in your favor and moves above the short strike, you will achieve maximum profit.  The maximum profit is calculated by the width of the strikes minus the debit you paid.

In this example, the width is 10 and the debit it 5.  So if the price goes above the short strike, you will collect a 5 dollar ( 10-5=5 ) profit.

If the stock moves against you and moves below the long strike, you will achieve maximum loss unless you adjust or manage your trade.  Maximum loss is simply the price of your debit premium.  In this case it is 5 dollars.

You will want to manage this trade by rolling the short strike down toward the long strike, while also narrowing the width of the spread.  

Rolling the short strike should gain you a credit ( lets say .30 cents ) while also narrowing the width of the spread.  This adjustment will lower the cost basis even if you continue to expect to lose money on the trade.

If the original debit was 5 dollars and you were able to get another 30 cents.  Then even if you still lose in the trade, your loss has decreased from 5 dollars to 4.7 dollars.

If the stock price now manages to rally ( before expiration ) and rally back above the short strike, you will now be profitable albeit a lesser profit than originally designed.  Remember that you managed this trade by bringing down the short strike and narrowing the strike width to 5 points wide.  Your profit is based now on a strike width of 5 minus the debit which is now 4.7.

If the stock price does not move at all, the short strike will expire worthless and you would keep the premium.

The long call is simply the change in the value of the stock, which in this case has not changed.

So the value of the option is the profit of the premium that was sold.  5 dollars.

Note that you can manage this trade by moving the short strike ( for a profit ) toward the stock price if you can get a credit and you remain bullish on the trade.  

Buying a naked call has negative theta.  The option loses value as the option approaches expiration.  The loss in value increases faster as time expires.

Selling a call has positive theta. The option benefits from time as it approaches expiration.  The option price will decrease allowing us to buy the option back at lower and lower prices as the option approaches expiration.

Infinite once the stock moves beyond the break even point ( stock price + debit paid )

The break even of a long call

( Long call strike price + net debit paid )

We generally look for 25-50% of max profit when closing diagonal spreads. Profit occurs when the long option moves further ITM and gains value, and/or if implied volatility increases.

We manage diagonal spreads when the stock price moves against our spread. In this case, we look to roll down the short option closer to the breakeven price, so that we can collect more premium and reduce our overall risk.

Rolling a trade is when you buy to close a near-term short option and sell to open a further-term option at the same or different strike price, while leaving the long option alone. 

By doing so, you will be generating extra credits.   Near-term option are cheaper than the further out options;  By rolling the trade, the strategy will generate more credits. The idea is that as you keep rolling the short option from one expiration to the next, you generate additional credits whether it’s done in a covered call or a diagonal.

The additional potential credits offset the cost of buying the stock (for a covered call) or the long option in the further expiration (for a diagonal).  The bigger the credits you get for the rolls, the more you offset the cost of the stock or the debit of the long option. On the flip side, with smaller credits for the rolls, you don’t offset the cost as much, and your risk (amount of potential loss) isn’t reduced as much. 

** Due in part to the uncertainty of the total credits you can get from the rolls, an adverse price move in the stock is still a risk to your positions.

Long call diagonal spreads should ideally be used in a stock is slightly bullish in the short term but very bullish in the long term.  

It should be set up in periods of relatively low volatility as you do not want the short option to be compromised by price sudden and extreme price movements.