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I am thinking of making such a trade:

  • BUY PUT $590 MARCH
  • WRITE PUT $600 APRIL

I have done some reading and it looks like a diagonal put spread, but the diagonal put spread uses an out-of-the-money put near-term expiration – “front-month” and a further out-of-the-money put, with expiration one month later – “back-month”

Help?

Thanks

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This is a Short Diagonal Calender Put Spread

Generally, you're writing that long dated one at the money, and buying the short dated one out of the money.

The maximum amount that can be made is if the stock breaks out strongly to the upside, and you keep the upfront credit minus whatever small amount it took to buy the April puts back.

You can also make money if it breaks strongly to the downside, but only if the credit when you opened your positions was more than $10.

Example:

  • Scenario (A) you sold the April $600 put at $12 and bought the March $590 put at $1, for a net credit of $11/share or $1100.
  • Scenario (B) you sold the April put at $8 and bought the March put at $2 for a net credit of $6/share or $600.

Now say the stock falls to $500 by the time of that march expiration. You'd make $90/share on the march put, and lose $100/share on the April put (or a little more; but that deep in the money, there won't be much premium on it). That's a loss of $10/share, or -$1000.
So:

  • Scenario A: $1100 credit - $1000 loss = $100 profit
  • Scenario B: $600 credit - $1000 loss = -$400 loss

I make a point of pointing this out because in that article I linked to the fact that your upfront credit needs to be greater than the strike spread in order to profit to the downside is not clearly mentioned.

  • Dear Patches, thank you very much for your great answer! – user1053408 Mar 3 '12 at 7:30

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