Hi ,this question is for all you advanced pros out there. I would really appreciate a brainstorming session
This is a defense strategy discussion for diagonal put spread. Hence, my assumption is bearish bias
My definition of this trade is long ITM Put longer dated (70-80 delta) and short put near term (30 delta). This is a debit and Of course I will ensure my debit paid is less than the width of the strikes.
How the trade plays out
Scenario 1) Stock stays were it is, so my short put loses value rapidly but ITM put loses negligible amount. This is very good scenario and profitable. What I would do is roll out the short option to next week and collect even more credit without altering the width of spread. Alternatively, I may close the whole position and pocket the profits on expiry day.
Scenario 2) This is my ideal one. Stock smashes pass the short put and it is shows loss. However, the vega on the long put would make it so valuable that overall position is highly profitable especially if leveraged well. So, on the weekly expiry I close the entire position, take profit and reset the trade.
Scenario 3) The not so fun part . Stock becomes very bullish meaning the Put you bought is starting to lose value rapidly. Of course, you are gaining on short put , which I would roll rapidly to next cycles until it hits the expiry date of the long put which would make it a bear put spread.
This discussion is all about scenario 3. Diagonal is very flexible so you are always left with something. But, we need to figure out how to recover our initial investment in long put if the stock continues to climb and makes the long Put that was ITM into OTM,
One proposal is if the stock moves so much against my assumption , I would almost certainly run a cal diagonal spread* in parallel which would surely be very profitable.
I was also thinking of moving the OTM put 1 strike below the long put and capture as much premium as I can. This of course goes against not interfering with with of spread but if long goes OTM from ITM, then your assumption is clearly long and objective should be to limit damage.
I request you guys to suggest alternative solutions to defend against scenario 3. This is very important and would help a lot. Please reach out for any queries.
have a nice weekend, cheers