A bullish diagonal spread is an advanced option trade and generally not suitable for beginners, but it can have its place within an option portfolio.
It is a bullish strategy that benefits from time decay and is best placed when volatility is low, such as the current conditions.
The strategy involves buying a long term call and selling a monthly out-of-the-money call against it.
The trade is best placed when the trader has a bullish outlook and thinks the stock could get to the short call strike by the first expiration date.
A rise in implied volatility will benefit the trade as it has positive Vega overall.
The big risk with the trade is a sharp move lower early in the trade.
Let’s look at an example using Amgen (AMGN).
AMGN Stock Bullish Diagonal Example
Amgen is in a solid uptrend and is rated a Strong Buy. The Barchart Technical Opinion rating is an 88% Buy with a Strongest short term outlook on maintaining the current direction.
Long term indicators fully support a continuation of the trend.
Let’s look at how we can use options to find a favorable risk to reward trade on the assumption that AMGN stock might rally to $350 in the next few months.
We will look at a bullish diagonal spread which allows traders to get long AMGN without risking too much capital.
A bullish diagonal spread is a trade that involves buying a long-term call option and selling a shorter-term, further out-of-the-money call option.
Structuring the trade at $350 gives the trade around 24 delta, which is roughly equivalent to being long 24 shares of the stock.
Selling the October 18th $350-strike call option will generate around $410 in premium and buying the March 21st, $340-strike call will cost around $2,555.
That results in a net cost for the trade of $2,145 per spread, which is the most the trade can lose.
The estimated maximum profit is around $1,000, but that can vary depending on changes in implied volatility. The maximum profit would occur if AMGN closes right at $350 on October 18th.
The trade benefits from time decay as the short-term option will decay at a faster rate than the longer-term option.
The ideal scenario for this AMGN trade is for the stock to move towards $350 in the next few weeks.
A bullish diagonal spread is a good way to gain some upside exposure on a stock without risking too much if the move doesn’t eventuate.
The suggested stop loss level is a close below $310.
Here is a visual of what the trade looks like:
Company Details
Amgen Inc. is the leading biotech companies world wide, with a strong presence in the oncology/hematology, cardiovascular disease, neuroscience, inflammation, bone health & nephrology and neuroscience markets. It developed two most successful drugs, Epogen & Neupogen.
Amgen successfully launched two next-generation products, Aranesp & Neulasta and also a biosimilar drug, Prolia/Xgeva.
The acquisition of Immunex Corp gave Amgen access to the multi-blockbuster drug, Enbrel. Other products are Repatha, Blincyto, Parsabiv, Evenity, Aimovig, Lumakras/Lumykras, Kanjinti, Mvasi & Amgevita biosimilars.
Amgen also has a promising pipeline of cancer drugs. It has one of the strongest cash positions in the biotech sector, which could be used to acquire more pipeline assets that could fuel long-term growth.
The erythropoiesis-stimulating agents and granulocyte colony-stimulating factor franchise comprise Epogen/Aranesp and Neupogen/Neulasta respectively. Biosimilar drugs are also a key part of Amgen's growth strategy.
AMGN rates as a Strong Buy according to 11 analysts with 1 Moderate Buy rating, 11 Hold ratings and 2 Strong Sell Ratings.
Implied volatility is at 20.28% compared to a 12-month low of 16.53% and a 12-month high of 38.54%.
Please remember that options are risky, and investors can lose 100% of their investment. This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
On the date of publication, Gavin McMaster did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
