Should the short side of the calendar/diagonal spread expire worthless, that fact actually becomes the "free money" that "buys" the long side of the spread! If the reversion of the price cycle should come into play while long the remaining option (call or put depending), the value of that remaining naked long option can become quite valuable and profitable. All percentage-wise gains made on that long option are thus measured as per return on equity as infinitesimal, because they were paid for by the shorted/expired side of the calendar/diagonal spread!
The fact that the calendar/diagonal spread has two different strike prices and two different expiration months is what comprises the strategy. The spread attempts to capture premium decay as well as possibly "morphing" into a long call or put should all go "according to Hoyle"! "Hoyle" having the short side expire worthless as well as then the long side exploding in value -- the equivalent of options trading Nirvana!
On the way to that form of Nirvana, things can change and most times will! In fact, any time a calendar/diagonal spread strategy is employed, you should be on alert to adjust the spread if any change warrants adjusting. The calendar/diagonal spread executed the way I prefer is loaded with potential change, causing the adjustment tactic to come into play roughly at least half the time when using this strategy.
The following rules should be adhered to when using the calendar/diagonal spread strategy:
1) When in doubt, adjust the spread to either a vertical spread, or even consider closing it out.
2) Adjust from the short side first, covering the short side and then shorting the side that creates the vertical spread. That tactic ensures that you will not get "doubly" short contracts (puts or calls)!
3) Use the seasonal tendencies of the stock and the stock market as those seasonals have a very good track record!
4) Those seasonal tendencies have August to November as being skewed to the bearish side while December to April being skewed to the bullish side.
5) Be very aware of the seasonal aberration stated in #4. Any aberration should be highly respected as being a serious trend reversal that will trap a high percentage of traders (i.e." long and wrong" or "short and squeezed"!).
6) Do the shorted side of the calendar diagonal either out-of-the-money or at-the-money, unless the shorted side, while in-the-money, offers some time value/premium decay that can be sold short.
7) Never do a calendar/diagonal for a debit.
8) Be aware of ex-dividend dates as the shorted side of call calendar/diagonal spread can become an exercise on you the day before the ex-dividend date, and the put side an exercise to you after the underlying trades ex-dividend.
9) Chart the stock, looking for short-term weakness (if calls being spread) or short-term strength (if puts being spread) in an otherwise longer-term trending chart pattern that favors the long side of the calendar/diagonal spread.
10) Chart stocks to find reversion to the mean potential once the shorter-term side (the shorted side of the calendar/diagonal spread) of the spread expires. This is in tandem with #9.
11) Study and completely know the stock's fundamental situation and condition, as they must be in control for the long side of the spread to have any chance of being profitable.
12) Use only stocks with excellent options liquidity.
13) Know that the delta of a calendar diagonal will be at inception slightly bearish (if calls) or slightly bullish (if puts). That delta differential should not be a concern unless executing in large size of contracts.
14) Only execute this strategy if 100% committed as well as 100% confident of the strategy!
15) This strategy is for very experienced options traders only!