Buying a diagonal spread

Discussion in 'Options' started by surfer25, Jan 27, 2011.

  1. Hi,
    If I buy a feb put and simultaneously sell a jan put, what is my risk if I am assigned?

    1. Sell Jan 28th 100 put for $3
    2. Buy Feb 19th 100 put for $7

    What happens if the stock drops to 80 and I am assigned on Jan 28th?

    Am I covered for any price swing with a max loss of under $7?

    Thanks.
     
  2. either exercise your back month put or sell it out.
     
  3. I appreciate that, but I am wondering what my max risk is if assigned.
     
  4. Maximum loss is $4 not $7
     
  5. As Spin mentions, the max risk is $4 per position.

    If you are assigned, you would own stock worth $8000 that you paid $10000 for - the Feb 100 put with the stock at $80 would be worth at least $2000 - so $10,000 value with $10,000+$400 paid.

    If the stock continued to fall to $60, you would have stock worth $6,000 and a put worth $4,000.

    Of course, this is only up until Feb 19th, when you would probably want to close your put and/or roll it to a future expiration (for a cost of course).

    JJacksET4
     

  6. Thanks for explaining that. I assumed that my max loss was $4, but certainly under $7 in any event. I have never been assigned, so I don't know exactly what takes place in the event of an assignment. I was wondering if I could get assigned overnight, and if so, would any fluctuation put me at greater risk than the cost of the back month minus the credit from the front month. It appears from your answer that regardless of the amount the stock moves in either direction after assignment, that my max loss is $4, (up until the feb put expires).

    I have never traded calendar spreads before, so I wanted to make sure I understood the risk in the event of assignment.

    Thanks.
     
  7. MTE

    MTE

    In the thread title you mention a diagonal, but the position you are describing is actually a calendar. A diagonal would have different strike prices in addition to different expirations.

    As to the risk, as it has been pointed out your risk is only $4. Assignment on your short Jan put results in a long stock position. However, since you would still have the long Feb put, your position would be long stock+long put, which is a synthetic long call, and the risk on a long call is limited to the premium paid, which in this case is $4.
     

  8. Yes, I realized that I called it a diagonal, and it is really a calendar spread. I was also wondering if I am assigned when the stock is at 80, would it be best for me to hold it for a while to see if the stock price floats up in the hope that the put option I still hold would not decrease in value as much as the stock appreciates?

    I am asking this because at 20 points below strike, the option probably would not have any time value, but as the stock price comes back closer to the strike, the Feb option I would still be holding might acquire some time value, which would lessen my loss.

    Also, I would have little to lose on the down side because the option I would be holding would not lose any more time value as the stock declined since the time value would probably already have gone out of it when the stock dropped 20 points.

    Thanks.
     
  9. MTE

    MTE

    Obviously, once the stock gets down to 80, and (if) you get assigned then, assuming you have enough buying power and desire (i.e. there is an opportunity cost of having you capital tied up) to hold the long stock, there is no harm in holding on to the position for a chance the stock bounces back up.