TOOLS OF THE TRADE

THE REVERSE COLLAR

Last week we discussed the Collar Trade which is comprised of three trading instruments 1) Long Stock 2) Long Put and a 3) Short Call. Although the Collar is a heavily hedged trade that can optimize bullish, bearish and stagnant trends, its’ construction is slightly bullish bias. This week, we will be covering the mirror image of the Collar Trade, the Reverse Collar.

The Reverse Collar has the same heavily hedged aspect of the standard Collar, however, the trade’s configuration is slightly bearish in its’ construction. It also has the ability to optimize trends in any direction.

There are two reasons the trade may not be quite as flexible as the standard Collar 1) It involves shorting the stock and as such, the strategy may not be appropriate for qualified accounts like IRAs 2) Stocks can only go to zero and since the primary component of the Reverse Collar is short stock, the trade is a bit more limited as opposed to long stock in a standard Collar.

The Reverse Collar has three legs 1) Short Stock 2) Long Call and a 3) Short Put. The Short Stock optimizes a bearish trend; and the Long Call limits losses should the underlying rise which is adverse to a short stock position. Finally, the short put is sold at a credit to help finance the protective long call.

Study the risk graph and you should gain an understanding of the risk and reward of the Reverse Collar. Best, Robin

Bookmark It

Hide Sites