Have you ever looked at a stock or ETF and thought to yourself, "I think that's going higher"? The follow up question is then "How do I play the move"? There is no perfect answer to that last question, but this post offers a possibility.

Many option traders, especially those who are new to the profession, have an inclination to simply buy calls if they are bullish. In theory this can be a very profitable way to trade. However professionals are aware of a couple of things that give them an advantage over the amateurs.

1. Often what one think will happen simply does not
2. Even if correct, buyers bleed from the negative effects of time erosion

The flexibility of the options market allows an investor to combine strategies that reflect a directional bias while reducing directional risk and offering profits through time decay. One of the many combinations one might consider is a diagonal spread.

Let's take a look at an example of a bull call diagonal using the Chinese ETF, FXI as the underlying product. See the chart below.

After a five-month period of price decline, the stock begins showing signs of life. In the past month the stock has seen the formation of new higher highs and higher lows. One could easily expect prices to go higher from here as this trend continues.

To create a bull diagonal spread, start with the purchase of a longer dated in-the-money option. Look at calls within a delta range of .60 - .70 that are 3-6 months out. These options carry a lot of leverage. That's good if the stock goes up, bad if the stock goes down. They also carry the negative expense of time decay.

To off set some of the directional risk and actually turn the time decay into a money maker, one might sell front-month calls with a delta in the .30 - .40 range. By doing this all the profit potential of a long vertical is created. The trade can become worth the difference between the strikes. This trade also has the availability of "rolling out" by selling calendar spreads at the short strikes every month. This provides income and lowers the cost basis. In short the diagonal makes money if the stock goes up and pays money through time decay. Sounds like a good combination on a bullish stock, doesn't it?

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