The Collar Option Strategy
By Options University
How The Collar Option Strategy Can Influence Your Profits
The Collar Option Strategy
Another protective option strategy that allows for some upside
capital gain while providing maximum down side protection is
the collar option strategy
The collar option strategy is a combination of the covered call
option strategy and the protective put option strategy. The
collar option strategy uses a long put position in coordination
with a short call position along with a long stock position.
The ratio is one short call, one long put (not of the same strike)
and 100 shares of stock.
As you remember, one contract is equal to 100 shares. The options
that we will use to construct this option strategy will be out-of-the-money
puts and calls.
The object here is to construct a protective put option strategy
without having to pay for the purchase of the put. We talked
about premium in the covered call option strategy and how we
are better off collecting premiums over a period of time, not
paying them out. By selling the call, we collect premium which
can be used to offset the capital outlay we incurred for the
We said that two of three scenarios in the covered call option
strategy were positive while the protective put scenario had
only one scenario that produced a positive outcome.
However, the protective put was the option strategy that provided
the most downside protection. The challenge was to construct
a protective put option strategy without paying out money. The
solution is the collar strategy.
The collar takes on the characteristics of both the protective
put option strategy and the covered call option strategy. Like
the covered call option strategy, there is an upside cap on
profits and like the protective put option strategy there is
unlimited downside protection.
Ideally, the collar is set up to be an even trade meaning
you neither receive nor pay out any money. Realistically, depending
on the options used, you may have to pay out a small premium
or even receive a small premium but the goal of the collar in
terms of premium is to be neutral.
As mentioned previously, to construct a collar, just buy one
out-of-the-money put and sell one out-of-the-money call per
every 100 shares of stock owned.
Obviously, the put and the call must be of differing strikes
(it is impossible for a put and a call of identical strike price
to both to be out-of-the-money or both to be in-the-money).
For example, with a stock priced at $28.50 a collar may be constructed
by the purchase of the December 27.5 puts and the sale of the
December 30 calls. Hopefully, the price of the call and put
are close enough so that the funds generated by the sale of
the call are enough to offset the cost of the put purchase.
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