Diagonal
Put Spread
Description
This
trade is a combination of a Bear Put Spread and a Put Calendar Spread.
Buy
at-the-money (higher strike price) put with 60 days or greater to expiration.
Sell
out-of-the-money (lower strike price) put with at least 30 days until
expiration
and
at least 30 days less until expiration than purchased put.
Market
Opinion
Bullish.
P/L
When
To Use
Use
this strategy when you are in a bullish environment and want to generate
income.
Example
XXXX
is trading at $26 on May 10, 2011. There is normally 40% volatility associated
with the stock.
Buy
January 2013 25 puts at $4.00.
Sell
June 2011 27.50 puts at $2.20.
Benefit
With
this strategy you can generate monthly income, benefiting from range bound
stocks.
Risk
vs. Reward
The
risk is that there is uncapped downside, and can lose on the upside if the
stock price increases. The reward is monthly income and a higher yield than if
you had used a naked put or covered call.
Net
Upside
It
depends on the value of the long put when the short put expires.
Net
Downside
Higher
strike minus maximum long put value at first expiration minus net credit.
Break
Even Point
It
depends on the value of the long put when the short put expires.
Effect
Of Volatility
N/A
Effect
Of Time Decay
Negative
for the long put over time. Decays the value of the short put faster, according
to how in-the-money it is.
Alternatives
Before Expiration
If
the stock trades outside the higher or lower stop loss zones, you can reverse
your position.
If
the stock goes higher than the higher strike yet is under your higher stop
loss, then your short put expires without value. You can then write another put
for the next month. In the meantime, the long put has reduced in value.
Close
out position if it drops to 60% of purchase price.
Alternatives
After Expiration
If
the stock is between both strike prices, you will be exercised. Sell the long
put and by the stock at the higher strike price, then sell it at market price.
