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A bullish diagonal spread is an advanced option trade and generally not suitable for beginners, but it can have its place within an option portfolio.

It is a bullish strategy that benefits from time decay and is best placed when volatility is low, such as the current conditions.

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The strategy involves buying a long-term call and selling a monthly out-of-the-money call against it.

The trade is best placed when the trader has a bullish outlook and thinks the stock could get to the short call strike by the first expiration date.

A rise in implied volatility will benefit the trade as it has positive Vega overall.

The big risk with the trade is a sharp move lower early in the trade.

Let’s look at an example using Robinhood Markets (HOOD).

Robinhood Markets looks to be sparking back up after crossing above the 50-day moving average on Monday.

Of the 24 analysts following Robinhood 15 have a Strong Buy rating, 2 have a Moderate Buy rating, 4 have a Hold rating and 2 have a Strong Sell rating.

Let’s look at how we can use options to find a favorable risk to reward trade on the assumption that HOOD stock might rally to $85 in the next six weeks.

We will look at a bullish diagonal spread which allows traders to get long HOOD without risking too much capital.

A bullish diagonal spread is a trade that involves buying a long-term call option and selling a shorter-term, further out-of-the-money call option.

Structuring the trade at $85 gives the trade around 32 delta, which is roughly equivalent to being long 32 shares of the stock.

Selling the June 18th $85-strike call option will generate around $405 in premium and buying the July 17th, $70-strike call will cost around $1,335.

That results in a net cost for the trade of $900 per spread, which is the most the trade can lose.

The estimated maximum profit is around $675, but that can vary depending on changes in implied volatility. The maximum profit would occur if HOOD closes right at $85 on June 18th.

The trade benefits from time decay as the short-term option will decay at a faster rate than the longer-term option.

The ideal scenario for this HOOD trade is for the stock to move towards $85 in the next few weeks.

A bullish diagonal spread is a good way to gain some upside exposure on a stock without risking too much if the move doesn’t eventuate.

The suggested stop loss level is a close below $73.

Here is a visual of what the trade looks like:

Robinhood Financial LLC is a registered broker dealer. Robinhood Securities, LLC provides brokerage clearing services. Robinhood Crypto, LLC provides crypto currency trading.

Implied volatility is at 59.51% compared to a 12-month low of 49.53% and a 12-month high of 90.94%.

Robinhood is due to report earnings on July 29th, so this trade should not have any earnings risk.

Please remember that options are risky, and investors can lose 100% of their investment. This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.

On the date of publication, Gavin McMaster had a position in: HOOD. All information and data in this article is solely for informational purposes. This article was originally published on Barchart.com