Collar Position

| December 8, 2011 | 0 Comments

A collar position is a unique strategy.   It’s usually used with a long stock position to prevent risk over a certain time frame.  The collar is basically a covered call position with an extra long put.

Take a quick look…

You own 100 shares of Microsoft at $25 a share, and all of a sudden it rises in price to $35 dollars.

You don’t really want to sell your stock, but you don’t want to lose the nice profits you now have.

This is what you’d do… pick a price you’d be willing to sell your position.

So, for your stocks protection, you sell a call option and use the proceeds to buy a put option in the same month.

For example…

Your Microsoft stock is up from $25 to $35 a share.  You can sell one Microsoft January $37.50 call option for $.20 per share.  Immediately after you would buy one Microsoft January $30 put option for $.16 per share.  This is a total collar purchase for a credit of $.04.  Meaning you get paid $4 to put your collar on.

Now three scenarios get occur…

At expiration, your Microsoft stock is at $37.50.   The $37.50 call option you sold will get exercised and you will be obligated to sell 100 shares of Microsoft at $37.54.  This represents your $37.50 plus the $.04 you collected.

If your Microsoft stock closes in-between $37.50 and $30, both contracts expire worthless.  You continue to own your stock at whatever price it’s trading.  In addition you keep the $.04 you collected for the position.

Lastly… your Microsoft stock closes at expiration at $27.  The call option you sold expires worthless.  Now, you exercise your $30 strike put, giving you the right to sell your 100 shares of Microsoft at $30 per share.  Don’t forget you also collected $4 for the position.

After the math… your stock is sold for $30.04 per share with Microsoft trading at $27 per share.  You’ve just saved yourself an additional $3 loss, or 10% by executing your collar.

One thing to remember… this is a risk versus reward strategy and you alone must decide at what price you’re comfortable being protected.

Category: Options Trading Strategies

About the Author ()

A former banking executive, Corey Williams is the Chief Options Strategist and co-editor of our well-known daily newsletter, Options Trading Research. Corey’s extensive experience with options goes all the way back to his days in corporate finance. It was this decade in banking where Corey discovered the most important skill an options trader can have– the ability to analyze a company or sector to determine its likely future direction. And now he’s brought this background, experience and love of options to Options Trading Research, the unique daily e-letter devoted exclusively to helping individual investors profit from the very lucrative options market.
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