Advanced question about Diagonal spreads

[RGLD]

I don't know how advanced this is, but I'm sure it happens a lot. (especially now)

Sell to Open Put ST $100 expiring 1/28.
Buy to Open Put ST $80 expiring 6/30.
Stock is trading at $90 when you engaged in the spread.

Next Day:

Stock drops to $70.

1) We can assume the 1/28 Put is worth ~$30 now since it's ITM and expiring, there shouldn't be much premium left if any.

2) I don't know how much the 6/30 put is worth since it's going to be ~$10 + time premium.

3) Since the short 1/28 $100 put has no premium value left, the longer it stays below 80, the more you will suffer on the 6/28 Put which has as much premium as a call at the same strike price.

So question, is it better to re-ramp this spread? Or just roll the 1/28 short to next week?

Option 1: Close the 1/28 $100 Put and Open another one at the same strike for next week.

Option 2: roll and change the Long Put. But close to the money because I don't want anymore direction risk.

Sell to Open $100 Put for 2/4.
Buy to Open $70 Put for 6/30.

If this rallies, I will be gaining $30 of intrinsic + premium. But my question is, is the $70 put going to eat most of the profit since it's so close to the money? I did not want to make it @ 60 because my max risk for the trade has already been reached. I might even Buy an $80 put instead. So both are going to be ITM. Obviously the $70 put will lose premium at a higher rate than the OTM $100 put but we're gaining direction value too during a rally.

Is it better to just go with option 1 most of the time? Or is option 2 better for potential rally + risk management?

Sorry for the long post, but as with most options strategies, it's long and complicated.

 

[xandman]

Sell 100 Shares of stock to be called away for the 1/28 expiration. Sell a new Put as you please. Doing it this way should minimize paying thru the nose on the b/a spread.

I can't say I can figure out why anyone would do this spread. If you are at the level of, " Well, if this option makes $10 and change and that option makes 20, then.....". Just stop. Don't go past 30-45 days expiration. There's them Vega risks out there. Nasty critters.

Btw, "Premium" is the value of the option which is composed of extrinsic + intrinsic value.

 

[RGLD]

Sell 100 Shares of stock to be called away for the 1/28 expiration. Sell a new Put as you please. Doing it this way should minimize paying thru the nose on the b/a spread.

I can't say I can figure out why anyone would do this spread. If you are at the level of, " Well, if this option makes $10 and change and that option makes 20, then.....". Just stop. Don't go past 30-45 days expiration. There's them Vega risks out there. Nasty critters.

Btw, "Premium" is the value of the option which is composed of extrinsic + intrinsic value.

I usually do a diagonal spread with the underlying price in between. Is this a bad idea or the 6 month long a bad idea?

Using my same example as long as I don't make the LONG PUT more than 30 days it's fine? It still doesn't answer the question about readjusting the spread though. Assuming I'm using the same 30 expiration date but at a lower strike.

 

[RGLD]

Here is what I did on SNOW today.

Stock closed today @ $244.72 I got in when snow was around $260. so it already went deep through my Long Put. Which is not what I wanted, I wanted the Short ST $262.5 put to expire worthless tomorrow.

Now I face the problem.. Should close the 255 Long and collect the $672 hedge and buy the same month at say Strike 240 for $23.60? Is that any more beneficial than just rolling the $262.5 to next week? The 262.50 short has no time value left now, so I'm only hurting by holding the 255 LONG.

 

[xandman]

I usually do a diagonal spread with the underlying price in between. Is this a bad idea or the 6 month long a bad idea?

Using my same example as long as I don't make the LONG PUT more than 30 days it's fine? It still doesn't answer the question about readjusting the spread though. Assuming I'm using the same 30 expiration date but at a lower strike.

Well, since this has turned into a conversation. It is a bad idea only that I don't understand it. And, 6 month long is a bad idea only if you do not understand the risks at play. The far away months have more significant VEGA risk: risks of changes to implied volatility. That's what your betting on here. In fact, the trade seems to isolate a bet on VEGA mostly to the back months very well.

Imagine my confusion when you present to me this isolated bet and yet you are making rudimentary calcs that just clutter up your whole thread starter. So, your either expert or shook up the ol' bag of option trades.

Going from 6 months to 1 month radically changes the exposure on this spread by magnitudes to much less VEGA and to much more DELTA. You have to model it to see changes with price, time and the levels of volatility in both expirations. In fact, most brokerages can't handle the modelling IV across different expirations. So, shouldn't you mitigate this risk? I think so.

 

[xandman]

Here is what I did on SNOW today.

Stock closed today @ $244.72 I got in when snow was around $260. so it already went deep through my Long Put. Which is not what I wanted, I wanted the Short ST $262.5 put to expire worthless tomorrow.

View attachment 276611

Now I face the problem.. Should close the 255 Long and collect the $672 hedge and buy the same month at say Strike 240 for $23.60? Is that any more beneficial than just rolling the $262.5 to next week? The 262.50 short has no time value left now, so I'm only hurting by holding the 255 LONG.

The big question is: What is your desired exposure?

My guess is you want still to be Short Theta and Long Delta because that was the initial exposure. If so, a better expression of that is a short put spread in the same expiration.

Match the Mar18 255P with higher strike Put that will give the net Delta exposure that you are comfortable. Delta will more likely be the primary source of your gains (you have to make the right directional bet as with most things) and Theta is having the wind to your back. Like a dividend stock, but the similarity stops there. You're upside is capped. And so, is that (GAMMA) upward impulse when the stock moves in your direction.

I love Gamma so I go long an option which is short THETA. The more theta I pay, the higher Gamma I get. There is an expression that "gamma kills". Well as your my competitor in the market, I want to kill you....with GAMMA. It's mostly about expectations on volatility.

I think you found your way to this trade via the modeler. If so, brush up on your knowledge of the Vol Skew and Vol Curve.

 

[RGLD]

I want the underlying to go up yes. Having a put spread on the same expiration would not give me the benefit of having only a $171 loss when the trade went -$10 against me. It would be much higher. I guess that is what you mean when Theta is on my back? They don't work together, if I'm gaining on Delta ( like I want) I'm losing value on the theta. Theta is only like a dividend when you're short.

I've been trading like this because I like the extra benefit of having reduced losses if the trade goes against me and if it goes my direction, I would roll it up higher. The other issue is if the underlying goes up too much, it'll eat your profits from the LONG unless you roll up the front month to a higher strike price asap.

 

[MrMuppet]

I really don't get it how retailers think about these spreads. What you are doing should depend on the price you can execute.

When the roll is more profitable, then for the love of god just roll. If you cannot evaluate which action is better, you should not put this position on

 

[newwurldmn]

I really don't get it how retailers think about these spreads. What you are doing should depend on the price you can execute.

When the roll is more profitable, then for the love of god just roll. If you cannot evaluate which action is better, you should not put this position on

Looking for an algorithm when they should be asking why are they trading anything....

like n Jurassic Park: Your scientists spent so much time figuring out if they 'could,' they never asked if they 'should'

 

[RGLD]

There is no doubt if I "should" be doing this trade. I definitely should as I posted my small loss after a $10 drop. I just don't know if one is better than the other. That's why it's more on the advanced side.

Also it's impossible to know how much a diagonal spread will be worth when one leg expires. There are models that can predict, but it's not as clear cut as a same expiration spread. That's why those options examples you always see always talks about what the value is worth at expiration. Very rarely do they ask you, if one options expires OTM how much is the remaining option worth that is 2 months out and $X.xx away from strike price?