Diagonal Bear Spread

Diagonal bear spread is the option strategy with limited risk and profit, which lies in the simultaneous buying and selling 2 puts on one asset with higher/lower strikes and longer/shorter expiration.

This option strategy is usually used when an investor is bearish on the market in the long-term but has neutral outlook in the near term. For this purpose, he buys a put to earn profit from the downward movement and sells another put with a closer expiration date. So, an investor wants at first the underlying asset price to stay around front-month strike and then when the short-term put expires worthless, he can write one more contract and repeat this process until the back-month option expires to reduce the overall cost of the trade by receiving the premiums.

Diagonal Bear Sprerad

Suppose, when the underlying asset price is $120, someone runs diagonal bear spread by buying the NOV $120 put for the premium of $250 and selling another AUG $110 put for the premium of $100. So, the debit is $150. If the price falls to the level of $114 and closes at this mark at the expiration date in November, this long-term option has $600 in intrinsic value. Suppose, in case of selling 2 more options with the same strikes and premiums when previous short-term contracts expire, an investor receives $200 ($100*2). Thus, his total profit is $650 ($600+$200-$150). If the price rises to the level of $125 and stays at this mark till November, an investor won’t be able to write additional options and will suffer losses which equal $150 (entire investment).

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