trade provides stock ownership, with a put for downside protection, paid
for by selling a call. The collar can also be used as part of a dividend
option-info and options-graphs sites:
Outlook: Bullish. The stock must rise to have a gain.
buy stock, buy put using the next strike price below the current
stock price, sell call using the next strike price above the current stock
when: Stock rises by the expiration date.
Gain: Limited to the strike price of the short calls - the stock
buy price + the credit for the option portion of the trade.
when: stock falls.
Loss : limited to the stock buy price - the put strike + the option
Calculation: Stock Price bought - option credit.
compared to stock: Stop loss.
compared to stock: Limited potential gains.
after entry, increasing implied volatility is negative if the stock
rises, but positive if the stock falls.
after entry, the passage of time is positive if the stock rises,
but negative if the stock falls.
Requirement : None. Initial debit must be paid in full.
Using an ATM strike for the put costs more, provides more protection,
and the stock must rise more for the entire position to be profitable.
Using an ATM strike for the call gives more "downside protection"
but severely limits possible gains.
Equivalent: Bull Call, ITM.
- This strategy
might be used if you want to be a stock owner, and you want a protective
floor under the stock to limit losses, and you want to pay for all or
part of the cost of that protection by selling call(s).
- The long
put(s) put a protective floor under the stock, limiting the loss on
the position no matter how far the stock might fall.
- The short
call(s) help pay for the put(s) but limit your potential gains as well.
For this reason, the investor should not be "too" bullish
on the stock. If the investor thought the example stock might go over
$55 before expiration, a better strategy would be the Married
- This strategy
is helpful to those who want to buy stock but are not sure of their
timing. Many stocks that end up moving higher can get very volatile
right around a good entry price. That can cause normal stop loss techniques
to trigger and take you out of the stock. With a Collar, the investor
can just relax during the life of the put, since market swings do not
matter. Only where the stock is on expiration day matters.
- A stock
investor may enter all new stock positions with the Collar strategy.
If the stock moves higher as expected during the life of the put, the
investor can then let the put expire and possibly switch to using trailing
stops to limit losses. If the stock does not move higher, the put will
limit any losses on the position to the amount that was deemed acceptable
on entry of the position.
use for a collar is to capture the dividend in a high yield stock. Before
the ex-dividend date, a collar can be set up to limit your possible
loss on the stock due to any unforeseen events. After the dividend is
captured, the entire collar trade can be exited. Depending on the stock
movement, there may be a loss or gain on the collar. Use an option calculator
or option graphing software to be sure the trade, with entry and exit
commissions and the captured dividend, has a good chance of being profitable
overall. Since you are attempting to profit by the amount of the dividend,
you do not care about stock movement, so you can use ATM puts and calls
to set up the trade. Normally if you bought stock at $50 for instance,
and sold the 50 strike call and bought the 50 strike put, there would
be no overall gain or loss no matter what the stock did. But if you
can capture a large dividend, it may make sense. A complicating factor
with this strategy is that both puts and calls will normally be priced
as if the dividend had already been paid, in other words, as if the
stock was trading at a price lower than the actual current price, by
the amount of the dividend.
the life of the options, the position has the same profit and loss potential
as the Bull Call, -1 to +1. So an
alternate strategy for a stock investor would be to buy In-the-Money
Long Calls and sell Out-of-the-Money Short Calls on any stock he wanted
to own. If the stock rises in price as expected, the long calls can
be exercised to buy the stock at the strike price of the long calls.
If the stock does not rise, the loss is limited to the cost of the options.
This technique has the added advantage of requiring much less investment
capital up front. The investor will only need to make a large investment
of capital in the stocks that he knows are working out.
- The example
Collar needs an investment of $4986 to establish. Buying the Bull Call
to use the technique described above would cost about $494. If the stock
then rose as expected, the long call could be exercised to buy the stock
at the strike price, which would be another $4500 invested. The investor
using the Bull Call technique only needs to use large amounts of capital
on the stocks that are already working, and only after the fact. Using
the Collar requires the full investment up front, before the investor
knows which stocks are working out.
this is a bullish position, the investor is obviously expecting the
stock to move higher. If the stock does not move higher, and the time
to expiration gets to just a couple weeks, it is usually wise to exit
the trade, taking less than the maximum possible loss.
- If the
investor is still bullish on the stock but feels he may have missed
on the timing, the currently held options can be "rolled"
to ones expiring in a later month.
- If the
stock moves higher as expected, the investor can close out the options,
and switch to another stop-loss technique such as a trailing stop entered
with his broker.
- If the
stock moves higher than the short call strike, an investor that thinks
the strike price of the short call represents a good selling price for
his stock can just allow his stock to be called away at expiration.
The long put will expire worthless.
- If the
stock moves higher than the short call strike and the investor wants
to keep the stock, he must buy back the short calls. This will result
in a loss of opportunity at least equal to the amount the stock has
gone over the strike. For instance, if the example stock went to 60,
it would cost at least $5 to buy back the 55 strike calls, meaning the
investor gives up any gains over 55.