Lets 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
are at the point where they will be called away.
Capital gains of the position are maximized when the commodities
options reach the calls strike price. Lets 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
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. Lets 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
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.