Diagonal Put Spread
This trade is a combination of a Bear Put Spread and a Put Calendar Spread.
Buy ATM (higher strike price) Put with 60 days or greater to expiration.
Sell OTM (lower strike price) Put with at least 30 days until expiration
and at least 30 days less until expiration than purchased Put. This is a
good trade to do with LEAPS in combination with short-term options.
Entry Rules
Bearish expectations for the underlying asset, but you don?t expect stock
price to move too quickly.
Pay no more than $4 for a $5 spread, and $8 for a $10 spread, including commissions.
Implied Volatility Skews of sold Put at least 10% greater than purchased Put.
Exit Rules
- Close position if it falls to 60% of purchase price.
- Hold position until expiration week of the sold option.
If the stock price is less than the strike price of the sold Put option,
you have two choices:
- Exercise your purchased Put option to cover the stock you must purchase
when the Put option you sold is exercised, and take your profit; or
- Roll forward to the next month - buy back the Put option you sold and sell
the next month?s Put option at the same or lower strike price depending on
the Put option prices and your outlook for the stock.
If the stock price is greater than the strike price of the sold Put option,
it will expire worthless.
Sell the next month?s OTM (lower strike price) option on the Monday following
expiration.
If the option you purchased is entering its final month before expiration,
close the position, or keep the Put or convert to a Bear Put Spread depending
on your outlook for the stock.
Profit & Loss Calculations
Maximum Risk : Limited to the net debit paid for the spread
Maximum Profit : Limited to difference in strike prices - net debit paid
Breakeven : Higher Put strike price + net debit paid
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