Shares of Adobe crashed last week. Adobe stock fell 24% in huge volume following news of its acquisition of Figma for $20 billion. When such a quality company has a big drop like this, I like to use a strategy called a diagonal put spread.
Treat this option strategy as an advanced strategy. The reason? It utilizes options over different expiration periods and different strike prices.
Adobe Stock Today: How To Set Up The Diagonal Spread
The trade involves selling an Oct. 21-expiring put option with a strike price of 260 and buying a Nov. 18 put with a strike price of 245. The long put has more time before the option contract expires.
As of Tuesday's close, the October put for Adobe stock could be sold for around $4. And traders can buy the November put for $4.10. The net cost on the trade would be $10, the most the trade could lose on the upside.
The risk with the trade is on the downside, with a potential maximum loss of $1,510. You can calculate it by taking the difference in the spread between the two put options, or 15, multiplied by 100 and adding in the cost of the trade ($10).
The maximum potential gain may hit around $550, if ADBE closes right at 260 on Oct. 21.
The trade has a nice profit zone at 250 to 303. Yet aiming for a return of around 10% to 15% makes sense, and I would set a similar stop loss.
Biggest Risk In This Trade
The worst-case scenario arrives with a sharp drop in Adobe stock early in the trade. For this reason, if the stock drops below 260 in the next few days I would consider closing the trade early to minimize losses.
The initial trade setup has a delta of 2, meaning the position is roughly equivalent to owning 2 shares of ADBE stock. Note that this delta number can change significantly as the stock starts to move.
According to the IBD Stock Checkup, Adobe stock ranks No. 2 in its group. It holsa a Composite Rating of 37, an EPS Rating of 92 and a Relative Strength Rating of 12.
Always remember that options are risky and investors can lose 100% of their investment.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
