When the Diode is missing, you can get NEGATIVE peaks that will go beyond the 12 volt power the transformer will work with and easily produce - too much back EMF from the modulation swing will damage the Driver and the Final.
- so, once it's in there - to keep everything working - don't short it out - short story...
Long story...read on...
The Clipper Diode - as they call it, just keeps the POSITIVE voltages into the circuit, it clips or stops the negative going ones that can kill the output transistors from too much negative voltage - being the voltage BELOW ground level the transformer will send out...Puts them in Reverse bias and will destroy them.
There is also a secondary effect of FM-ing - called PHASE modulation, that is added into that Transformers output - which places a LOT of power as an FM Component into the AM envelope - making it sound somewhat "fuzzy" and distorted. Some like this effect, but the radio isn't made for this type of operation.
Variable on the this radio is a lot like what you already have in line now. R49 is removed, you install the variable there at the holes - locate the driver and the NEGATIVE side goes to the Driver side Hole, the Input side is opposite hole, the power the goes in to the Driver, from the Audio Modulation Transformer.
If you wanted, you can make a fixed Swing - by removing R49 and using a Resistor Cap combo to try various levels of resistor to Capacitor values and listen to the results.
Then you can try to add a variable if you want, but again, a variable is what it is. It varies DC power but keeps audio passing thru it with little reduction - so it can sound distorted when you really swing it with low - carrier power to high power peaks. So that's why I wanted you to try the Resistor cap mod, then SELECT the right capacitor to achieve the effect you want ACROSS the variable range.