# Part 1: How The Collar Strategy Works In Different Scenarios For Commodities Options

Provided By Options University

#### How This Strategy Can Drastically Effect Your Commodities Options

Lets take a look at how the strategy works for commodities options with this position. For the sake of our illustration and to make our calculations easy let's establish the collar using the December 27.5 put and the December 30 call, with both sets of commodities options trading at \$1.00.

Remember the commodities options price was \$28.50. The cost of the collar will be \$0 because you paid \$1.00 for the put but you collected \$1.00 from the sale of the call. How does the collar work in our usual three scenarios: the up scenario, the down scenario and the stagnant scenario?

In the up scenario, we find that when the commodities options rise, the investor gains penny for penny until the commodities options reach the call strike. Once the commodities options reach that level, the position no longer gains because the commodities options are at the point where they will be called away.

Capital gains of the position are maximized when the commodities options reach the calls strike price. Lets take a closer look at what happens as the commodities options price goes up. With the commodities options at \$29.00, both the Dec. 30 calls and the Dec. 27.5 puts are out of the money and thus worthless. Since there was no debit or credit incurred in the options, the option profit (loss) is \$0. Only the stock position remains. The commodities options purchased at \$28.50 are now trading at \$29.00 for a \$.50 profit.

Let's raise the commodities options price to \$30.00. The puts and calls are again worthless so your profit (loss) is solely determined by the commodities options. The commodities options, which were purchased for \$28.50 is now worth \$30.00 and represents a gain of \$1.50. This \$1.50 gain is the maximum gain the position allows.

Once the commodities options go over \$30.00, the Dec. 30 call, which we are short, would become in-the-money and therefore the commodities options position would be called away at that price. When the commodities options price rises to \$31.00, the puts would be out-of-the-money thus worthless but the calls would be worth \$1.00.

You received no money for the establishment of the collar so you would have a \$1.00 loss in the options. Meanwhile, the commodities options that you purchased at\$ 28.50 are now worth \$31.00 at expiration, which is a \$2.50 gain.

Combine the \$2.50 gain in the commodities options with the \$1.00 options loss; you have a \$1.50 profit again. You may do this calculation with higher and higher commodities options prices but the outcome will always be the same. This example shows how your upside potential is limited.

Obviously, if the commodities options portion of the collar incurred a debit or credit, that inflow or outflow of money must be added to or subtracted from the stock gain to get the overall return of the position.

Normally, there will be a debit or credit incurred in the collar. It is usually difficult to find a put and a call that you want to use in the collar trading at an equal value. Lets use our last example with some minor price changes.

If the put had been trading at \$1.25 instead of \$1.00, then there would be a \$.25 capital outflow that would have to be subtracted from the \$1.50 gain to reduce it to only a \$1.25 gain.

On the other hand, if the call was trading at \$1.25 then you would have collected an extra \$ .25 which added to the \$1.50 gain would produce a \$1.75 gain. The cost of the collar always impacts the bottom line profit or loss of the position.

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