The Italy U18 international has attracted admiring glances from a number of Premier League clubs, with Everton also believed to be interested in the talented teenager.
Gunners boss Arsene Wenger sent scouts to run the rule over Diego during Monday night's development squad match against Crewe Alexandra, following his impressive return to form after a 10-month lay-off, caused by a cruciate ligament injury.
The 18-year-old was named on the bench for the Blades' FA Cup clash against Fulham on Sunday, but returned to U21s action after remaining an unused substitute for Nigel Clough's side.
Manchester United have also been credited with an interest in bringing the young striker to Old Trafford, after David Moyes identified Diego as a potential star of the future.
The Chesterfield-born starlet caused quite a stir in 2012 when he opted to represent Italy at youth international level, after receiving a personal call from the great AC Milan and Italy coach Arrigo Sacchi.
Diego has scored three goals in six appearances for the U18s team, having qualified to represent them through his father Cosimo who is from Naples.
A move to the Emirates Stadium looks to be the most likely destination for the Sheffield United scholar, though, with Wenger's reputation for nurturing and developing young talent giving Arsenal a slender advantage in the pursuit of his signature.
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