Options Trading Made Easy: Diagonal Bear Collar

Options Options Trading
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The diagonal bear collar, also known as a diagonal reverse collar, is set in the same manner as a traditional reverse collar, save for one key adjustment.diagonal bear collar
The reverse collar is comprised of:

  1. A short sale of the underlying;
  2. A long call; and
  3. A short put (with identical expiries).

By contrast, the diagonal version sees the call expire after the put.
That’s it?
You bet. But that small difference opens up an entirely different profit/loss profile for the trade. It still affords the trader solid protection, but also offers the possibility for unlimited gains.
Before we examine a real trade to get a better feel for the intricacies of the strategy, let’s quickly outline the component parts in a little more depth.
As mentioned, the diagonal bear collar requires:

  1. The short sale of 100 shares of the underlying.
  2. The purchase of a protective call with an expiry roughly three to four months out.
  3. The sale of a put with a shorter expiry to help finance the long call.

The strike price of the put should be set below the sell price of the shares.

Who Should Use It?

Traders who see an extended decline ahead for the underlying stock, but have less clarity on short-term direction, would be inclined to employ the diagonal bear collar. The goal is to protect the short sale in the event of a sudden rise over the near term, see the short put expire worthless, and then watch the underlying sink full fathom five into the depths.
Here’s a chart of Chevron (NYSE: CVX) to help us better appreciate the strategy:
CVX diagonal bear collar
With oil in a seemingly endless free fall, you’ve made considerable profits shorting the shares of Chevron and selling puts against them. But in March, when your put is triggered and the short sale is closed, you think twice about reactivating your “covered put” strategy.
Why? The price of oil appears to be on the rise, and you worry that a quick burst higher would put your short sale deep in the red. You need something safer.
After some consideration, you decide to institute a bear collar, but not a vanilla bear collar, because you’re convinced that the coming pop in oil will be short-lived. Instead, you opt for a diagonal bear collar, a strategy that will keep you protected while enabling far greater profits in the event of a continued decline.
By the end of March, you’re ready to act. With Chevron at $105 (red circle), you sell 100 shares, sell the June 100 put for $4 and buy the July 112 call for $3. Your total credit on the trade is $10,600 ([$105 + $1] x 100).
For the next six weeks the oil bulls hold sway, and you’re happy you bought the protective call.  But come mid-May, oil is back to its losing ways, and Chevron, too, starts tumbling.  By the June expiry your put closes at-the-money worthless, with the underlying at $100 (black circle).  A month later, the stock slides to $93, your long call expires out-of-the-money worthless and your profit is sizeable.
You close out your short sale for a gain of $1,300 ([$105 – $93 + $1] x 100).

But What If…

Had the stock traded below the short put strike at expiry, the gain would have been capped at $600 ([short price less put strike, plus premium taken] x 100).
Had it traded above the long call, the loss would have been capped at $600 ([call strike less short price, less premium taken] x 100).

You won’t find this anywhere else

You’ll never read about this powerful trading strategy in the Wall Street Journal. Or see it discussed on CNBC. 99 out of 100 brokers know nothing about it. Yet this nearly risk-free trading system has been able to turn $330 into $3,300. And it’s been put together by one man who wants to share its secrets with you. Discover them right here.

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