Diagonal put

Article contents



At a glance



Setting up the strategy


  1. Buy one long-term put option on the underlying stock.

  2. Sell one near-term put option on the same underlying stock.

  3. At expiration of the first near-term put option, sell another put option that expires one month after the first near-term put at the same strike price. Repeat as many times as you wish up to the long-term put’s expiration.

Who should run this?

Intermediate to advanced traders.

Margin requirements


Learn more about Questrade’s option margin requirements.

Strategy overview



A diagonal put is an option strategy in which a trader buys one long-term put option while simultaneously selling a near-term put option of the same symbol.


Market outlook


  • Near-term neutral
  • Long-term bearish

Strategy benefits


  • Offset the cost of the long-term put by selling several near-term, out-of-the-money puts
  • Considered a low risk strategy since the maximum loss is limited to the initial debit to enter into the strategy

Strategy downsides


  • Maximum profit is limited

Diagonal put example



Scenario

ABC shares are currently trading at $13 in February 2013, and you believe the stock will slowly drop over the next several months. To set up a diagonal put strategy, you do the following:


  • Buy ten June 2013, $13 long-term put options for $2190 ($2.19 option premium x 1000 shares)
  • Sell ten March 2013, $9 near-term put options for $60 ($0.06 option premium x 1000 shares)
To enter into this strategy, you will be initially debited $2130.


Possible results

  1. Upon expiration in March, the stock drops in price to $12.10, meaning the near-term put option expires worthless. This allows you to write another near-term option that expires in April at the same $9 strike price for $80 ($0.08 x 1000 shares), bringing your initial investment down to $2050.  

    The stock continues to slowly move downward for the next two months, and you write two additional near-term put options for $85 and $90, respectively. This brings your total investment down to $1875.

    Upon expiration of the long-term put option in June, the ABC stock closes at $9.90, meaning the long-term put finishes in the money and has an intrinsic value of $3100 ($3.10 per share). After subtracting your total investment of $1875 (remember: this number was brought down after writing additional near-term put options), your total profit would be $1225.


  2. At expiration in March, let’s say the stock moves up in price to $14. The near-term put option would expire worthless. If the stock continued its upward trend and in June was trading at $15.50, that option would also expire worthless, and you would lose your initial investment of $2130.

Profit and loss explained



Maximum profit


Maximum profit = option premium received from selling near-term put option - option premium to buy long-term put option + expiration value of long-term put

Maximum loss

Maximum loss = net debit paid to enter into the strategy


Break-even at expiration

Given the two expiration dates, there are too many variables are in play to accurately predict the break-even point.

Sample calculations



  • Stock value at start of strategy: $13
  • To execute the strategy: Buy $13 put option for $2190, Sell $9 put option for $60
  • Result: $2130 net debit at start of strategy
  • Sell three more put options after March near-term expiry in April, May, and June.
  • Result: reduce the net debit to $1875

Result 1

Stock price at expiration Profit and loss calculations 
$12.10 in March (first near-term expiry) $0.06 (option premium)
x
1000 (10 options contracts comprised of 100 shares each)
= $60 credit
$11.90 in April (second near-term expiry) $0.08 (option premium)
x
1000 (10 options contracts comprised of 100 shares each)
= $80 credit

$11.00 in May (third near-term expiry) $0.085 (option premium)
x
1000 (10 options contracts comprised of 100 shares each)
= $85 credit
$10 in June (fourth near-term expiry)
$0.09 (option premium)
x
1000 (10 options contracts comprised of 100 shares each)
= $90 credit
$9.90 in July(long-term expiry) $13 (strike price of long-term put option)
-$9.90 (stock price)
=$3.10 (intrinsic value)
x 1000 (10 options contracts comprised of 100 shares each)
-$1875 (cost to enter the trade after applying the near-term put option credits)
= $1225 profit

Result 2


Stock price at expiration Profit and loss calculations 
$14 in March (near-term expiry) $0.06 (option premium)
x
1000 (10 options contracts comprised of 100 shares each)
= $60 credit
$15.50 in June (long-term expiry) $2.19 (option premium)
x  
1000 (10 options contracts comprised of 100 shares each)
= $2190 debit

Maximum loss
= $2190 (debit) - $60 (credit) = $2130 loss


Note
: commission fees are not included in the above calculations.


Payoff diagram






Creating a diagonal put







Standard order details

Order detail

Description

Symbol lookup field

Click  and change the mode to . Then enter the symbol you want to buy or sell. The default expiration date, strike price, and strategy appear. 




Tip: click the Option tab to view a more detailed option quote.

Modify the expiration date, strike price, and option strategy accordingly. For more information, see Elements of an option quote.
Action

The buy or sell action is set for you when you select the strategy type.

Qty

Select a value using the arrows , or enter a value manually.

Note: by default, the quantity will be populated with the value set in your user preferences.
Order type Select the type of order you want to submit. When creating strategy orders, only Limit or Market order types are available. For more information, see Order types.

The limit order type requires you to fill in additional fields. Refer to the table section below for details.
Duration

Select a duration to specify how long the order should remain active. For more information, see Order durations.

Route Select a route or leave the selection at Auto to let the platform determine the best one. Canadian routes will be listed for Canadian symbols and U.S. routes will be listed for U.S symbols.
Sub-route

This field will be filtered according to the route selection. It indicates where you prefer the order to be executed. Leave the selection at Auto to let the platform determine the best route.

Note: sub-route selection is only available for Canadian symbols.
Order type-specific details
Limit price Enter your limit price:

  • To have the price fluctuate according to real-time data, select . The icon changes to a lock icon , which locks the limit price. Once locked, use the refresh button to automatically update your limit price.
  • To choose a custom price, select .
Note: if real-time market data is not available, the limit price will be blank and the float limit icon will be unlocked.






Note: the video tutorial above shows how to create a diagonal put strategy using IQ Edge; however, the principles are the same for IQ Web.
Tip: for an optimized viewing experience, watch the video on YouTube in full 720p HD. To open the video in YouTube, click the YouTube button in the bottom right corner of the video window and select the change settings icon to modify the video quality.


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