The Diagonal Collar Strategy

Joseph R. Stadelnikas, M.D., M.B.A.

Sept 2009, revised June 2018, 2022

Recent markets, with our economic problems, supply

chain, inflation, war in Ukraine, the uncertainties have fear
in many traders trading. When we finally have times
where a recovery maybe possible, it continues to decline.
Many have heard of the standard collar trade and it is a
great way to protect your investments. It is expensive and
greatly limits your upside profits.

A standard collar strategy is often used by an investor

who has accrued unrealized profits from shares of stock
already owned and wants to protect the unrealized profits
by purchasing a protective put. The investor should be
willing to sell his stock if his short call is assigned. The
investors primary concern is protection of profits accrued,
rather than increasing returns with stock appreciation.

A standard collar can also be employed by long-term

investors building a portfolio who are risk adverse. One
can achieve realistic returns with downside protection.
The strategy is often employed by covered call writers, as
it offers greater protection. A covered call caps an
investors upside return and a successful covered call
writer must protect his downside, if he is to be successful.
The collar is one alternative to limit the downside loss.

A standard collar consists of:

Owning or purchasing 100 shares of stock

Selling 1 ATM or OTM call

Buying 1 ATM or OTM put

Same expirations
A diagonal collar consists of:

Owning or purchasing 100 shares of stock

Selling 1 ATM or OTM call

Buying 1 ATM or OTM put

Expiration LP > SC

There are numerous combinations one can use to build a

collar strategy. One variation I have employed is the
diagonal collar, purchasing the long put further out in
time than the short call.

It is commonly understood by option traders:

One who sells month by month, increases their

annualized returns.

One who buys further out in time, decreases their

annualized costs.
If an investors’ intention is to hold the stock long-term or if
only 3 to 12 mos., he may be able to decrease his cost of
protection by purchasing a longer term put.

Traders often shun the idea of purchasing long-term puts

or Leap. IWM @ $198.72, the 33 dte $195 put is $7.37
however the same strike for the 461 dte $195 put costs
$22.29.

$7.37 / 33 = $0.223

$22.29 / 461 = $0.048 (0.048/0.223 = 78.3%)

Cost of protection decreased by ~ 78.3% with the longer

term put. This will vary based on underlying and the %
OTM the strike price is.

Like all things in option trading all advantages come with

disadvantages.
Let’s walk through a Diagonal Collar with IWM as
underlying.

Example: IWM @$196.73

Decide your Risk Mitigation Percent %

3% - 10% (decline from purchase price)

Buy IWM @ $196.73

Buy long put, expiration 06/16/23

Strike $195; premium $22.29, 461 dte, (<1 % OTM)

Cost of Insurance - $22.29 = $.048/day

Sell short call, expiration ~ 1 month

4/14/22 (33 dte)

We want to sell a call for a premium that covers the

cost of the protection, ie. 33 * $0.048 = $0.65 is the
premium sought

Strike $206; premium $3.37 > $0.65, cost of

insurance is covered
Net Premium = Call Premium – Put Premium = $3.37 -
$22.29 = - $18.92 (debit)

Net Debit = Stock Price – Net Premium = $196.73 –

(-$18.92) = $215.65

Maximum Risk = Stock Price – Put Strike +/– Net (C/D) =

$196.73 - $195 + $18.92 = $20.65

% Maximum Risk = Max Risk/Net Debit = $20.65 /

$215.65 = 9.6%

Maximum Profit and % Maximum Profit is only an

estimate, as the remaining value of the long put at the time
of each short call expiration is calculated using the Black-
Scholes pricing model and hence is theoretical.
Call Strike - Premium

All traders have different return goals. I have found the

returns decent in my long-term portfolio utilizing a diagonal
collar with good protection for a correction or bear market.
If you buy the longer term and sell the shorter term, you
must know how to manage the trade or you will lose more
than the initial risk mitigation percent.
Received short call premium = $0.81. Long puts below.

Stock declined to $148 (10%) at expiration of short call

Received short call premium = $0.81

Long Put value increased to $14.53 (up $7.16)

Roll the long put to 30 dte, sell a short call same
expiration.

You can see the net transactions. Stock declined 20%,

the diagonal collar net loss -$7.96, 4.8% decline.

The biggest problem comes should the stock fall during

the short term. Don’t ever sell calls at a lower strike
than the put strike, since you could lock in a loss on a
rally. Additionally, if the stock does fall, the short calls
available at strikes higher than the put strike will not
provide enough credit to recover the cost of the put by
selling calls.

Whenever you buy longer-term options and you sell

shorter-term options, regardless the strategy, you have
the same problem. If the stock moves in either
direction you may not be able to accumulate enough
credits to eventually recover the cost of the longer-term
option.

Why roll in when stock drops.

Case above you have unrealized profit of 7.16 in long put.

If you roll in to the 30 dte, you realize 6.02 profit

6.02/0.019 you just paid for 316 days
Theta days = 22.29 - 21.46 = 0.83 (3.7%)

Theta days & price = 22.29 - 17.77 = 4.52 (20.3%)

First CC, stock increases to $206 at expiration, your short call strike,
initially the stock-put strike (OTM) < 1% now has widen to (OTM) > 5%, the
long put is not providing the same protection. What is a possible solution.
Move the long put strike up from $195 to $ 205 and in from 6/16/23 to
1/20/23. It will cost about $0.75, but now protects $8.27 price gain.
I have done this when iwm was in a bull market,

When nervous of entering a market rising for fear of it reversing, works,

you know your risk. Each % gain, roll the strike up and move in to an
earlier expiration for little or no cost. Eventually roll in to a standard, not
diagonal collar.1