# Part 1: How Collar Strategy Works With Future Options In Different Scenarios?

Provided By Options University

#### The Proper Way To Apply The Collar Strategy To Your Future Options

Lets take a look at how the strategy works 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 trading at \$1.00. Remember our future 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 future options rise, the investor gains penny for penny until the future options reach the call strike. Once the future options reaches that level, the position no longer gains because the future options are at the point where they will be called away.

Capital gains of the position are maximized when the future options reach the calls strike price. Lets take a closer look at what happens as the future options price goes up. With the future 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 future options, the option profit (loss) is \$0. Only the stock position remains. The future options purchased at \$28.50 are now trading at \$29.00 for a \$.50 profit.

Let's raise the future options price to \$30.00. The puts and calls are again worthless so your profit (loss) is solely determined by the future options. The future options, which was 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 future options go over \$30.00, the Dec. 30 call, which we are short, would become in-the-money and therefore the future options position would be called away at that price. When the future 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 future options that you purchased at \$28.50 is now worth \$31.00 at expiration, which is a \$2.50 gain.

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

Obviously, if the option portion of the collar incurred a debit or credit, that inflow or outflow of money must be added to or subtracted from the future options 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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