Alphabet (GOOGL) was down big on Friday, dropping 5.4% compared with the Nasdaq’s 3.9% sell-off.
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GOOGL stock also closed near the low of the day, which is typically a bearish sign.
According to the IBD Stock Checkup, GOOGL stock is ranked No. 4 in its group and has a Composite Rating of 67, an EPS Rating of 89 and a Relative Strength Rating of 37.
This is the sort of setup I’m looking for when scouting for bearish option trades.
Today, I’ll look at a setup known as a diagonal put spread. This is a bearish option trade that benefits from further downside in the stock price.
Buy A Put, Sell Another Put
For GOOGL stock, I’ll be looking to buy a Dec. 16, 115 put for around $10.25 and sell an Oct. 21, 105 put for around $3.75.
The total cost of the trade is the net premium paid, estimated to be around $6.50, or $650 for a standard contract of 100 shares.
The strategy earns the most profit if Alphabet closes right at 105 at October expiry, where the profits are estimated to be around $500 per contract.
If GOOGL stock drops even further, the trade will still make around $300. This is the lowest profit if the stock drops and it doesn’t matter how far it drops.
If I’m still bearish on Alphabet after the Oct. 21 expiration, I can sell another monthly put or simply hold the long put. The cost will have been reduced by the premium received for any sold options.
The net delta on the trade is -21, so the exposure is roughly equivalent to being short 21 shares of GOOGL stock. But this will change as the stock moves and the trade progresses.
In terms of risk management, I would set a stop loss of 25%. And if the trade is down roughly $160, I would close it out.
Earnings A Factor To Consider
Alphabet is due to report earnings on Aug. 30, so it may pay to wait until after that event before entering the trade.
It’s important to 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.
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
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