Short Diagonal Bull Put Spread
Strategy Motivation
When you expect a large move in the underlying asset's price to be imminent, you can use the short diagonal long put spread strategy. And this strategy is better suited to upward breakout volatility in asset prices than downward breakout volatility.
Construction of the Strategy
The Short Diagonal Bull Put Spread strategy is constructed by selling put options with a longer-term expiration date while simultaneously purchasing the same quantity of put options with a lower strike price with a near-term expiration date.
Brief Description
When using the Short Diagonal Bull Put Spread strategy, selling longer-term at-the-money put options and buying near-term out-of-the-money put options is generally preferable. Because the income from selling the longer-term options is greater than the cost of buying the near-term options, making it a credit strategy.
However, you will need some option margin if the near-term options cannot cover the risk exposure of the longer-term options.
After opening the position, if the market breaks up immediately, the longer-term options' time value will immediately be depleted. As the seller of the longer-term options, you can profit from time decay.
At this point, the strategy is expected to achieve the potential maximum profit, the net premium received.
Suppose the market remains stable, and the near-term option gradually loses value. In that case, the buyer of the near-term option will lose money, and the seller of the longer-term option will not profit. Overall, this is disadvantageous to the strategy.
Suppose the underlying asset price falls to the near-term put's strike price when it expires. In that case, the near-term option will be worthless. Still, the longer-term option's value will increase, resulting in a loss to its seller. And the potential maximum loss for the strategy to suffer equals the price of the longer-term put minus the net option premium.
When the near-term option expires, if you do nothing, you will continue to hold the longer-term option. At this point, you will be holding a naked short put option. As the underlying asset's price can be zero, your potential max loss equals the strike price minus the net premium. At the same time, holding the longer-term option cannot result in further gains.
Gain & Loss
Breakeven: The breakeven point which cannot be accurately calculated in advance. Even if an options calculator is used, the result is only a theoretical simulation. As the market changes, the actual breakeven points depend on the actual price of the options, which will fluctuate due to volatility functions, time functions, and other influences.
Max gain: The net option premium received.
Max loss: The potential maximum loss is limited during the two options' existence. This cannot be calculated accurately in advance and depends on the longer-term option's price when it expires.
When the near-term option expires, the potential maximum loss is unlimited if you do not close the longer-term option.
This presentation is for informational and educational use only and is not a recommendation or endorsement of any particular investment or investment strategy. Investment information provided in this content is general in nature, strictly for illustrative purposes, and may not be appropriate for all investors. Read more
