In situ hybridization has become a powerful technique for dissecting nuclear structure. By localizing nucleic acids with high precision, it is possible to infer the native structure of chromosomes, replication factories and transcript processing complexes. To increase the value of this technique, we have established the limits of resolution of two-color in situ hybridization to chromosomal DNA in diploid chromosomes of Drosophila embryonic nuclei. Using high-resolution 3-dimensional optical microscopy and computational image analysis, we establish that we can distinguish the location of chromosomal sequences that lie 27-29 kb apart within a 40 kb transcription unit with an accuracy of about 100 nm. Contrary to observations made in mammalian tissue culture cells, we find that when the gene is expressed, it assumes an open configuration, and that the extent of decondensation is variable from chromosome to chromosome. Further experiments suggest that variation in gene structure results from asynchrony in transcriptional elongation. We suggest that the phenomenon we observe is the diploid analog to chromosomal puffing that occurs in the transcriptionally active regions of Drosophila polytene chromosomes.