The 28-year-old re-joined Atletico on loan from Wolfsburg last month and made a scoring return in the 4-0 win over Real Sociedad at the weekend.
"My relationship with Simeone was always spectacular," Diego told reporters.
"He's the best coach I worked with in my life. He helps a lot as a player and a person. That confidence he has in me has made a difference in the decisions I have made."
Diego previously played at the Vicente Calderon for one season in 2011.