However, he is yet to add to five Premier League appearances from 2017-18, with competition fierce for attacking positions in Guardiola's side.
As such, Diaz looks set to join Jadon Sancho – the ex-City winger who moved to Borussia Dortmund last year and subsequently broke into the England setup – in seeking opportunities with another elite European club, with Goal having revealed that an agreement with Madrid is close.
"The case with Brahim is simple. We want him. We want to extend his contract for four or five years," Guardiola told a news conference.
"We do absolutely everything for him to stay here. But it is in his hands
"My advice, if he doesn't want to stay, he has to leave. It's simple.
"Since we arrived we have protected him, the same as we spoke with Jadon, the same as the case with Phil [Foden]. But he has to decide, no more than that."
News of Diaz's apparent departure comes in the week England Under-21 midfielder Foden missed out on a start in the 2-2 Champions League draw at Lyon, despite Guardiola being without injured trio Kevin De Bruyne, Ilkay Gundogan and Bernardo Silva.
Sancho thriving in the Bundesliga arguably presents an uncomfortable parallel for the other jewels of City's heavily funded academy, but Guardiola believes the Premier League champions are doing all they can for their brightest young stars.
"They cannot say we did [not do] absolutely everything to take care of them. Them and their families. As human beings, as football players," he said.
"It is incredible how the academy takes care of these guys, how they teach them to be at a high level for a long time. In the end they decide. We cannot push harder than we push.
Guardiola added: "What we can do is work really well and speak with the families. We don't lie to them, we tell them the truth about how complicated it is in some situations.
"How many 18 or 19-year-old players are playing every weekend with the big clubs? Maybe there is one – [Kylian] Mbappe. The other ones, I don't find.
"[David] Silva, for example, went to Eibar in the second division when he was young. We have to speak to them about the process.
"What can we do? More than we have done? No way. The club did perfectly in all the cases, but the desire is the desire.
"Maybe in other places they will play, maybe not. So, we will see."
Foden is in contention for his first Premier League start against Bournemouth on Saturday, with Guardiola unable to offer updates on the condition of Bernardo Silva (muscular) and Gundogan (foot).
Gabriel Jesus is pushing for a return after sitting out the Lyon trip, although De Bruyne is set to remain sidelined as he recuperates from his latest knee ligament injury.