Collar
| B/S | Strike | Type | Price |
|---|---|---|---|
| Buy 100 Shares | N/A | Stock | $50 |
| Buy 1 | $49 | Put | $0.97 |
| Sell 1 | $51 | Call | $1.00 |
| Net Debit | $5,003 | ||
A Collar is being long the underlying asset while shorting an OTM call and also buying an OTM put with the same expiration date.
The Max Loss is any loss taken on the stock +/- the premium for the options. The loss on the stock will be the purchase price of the stock minus the strike price of the put option (as you will exercise at that price) plus the net premium paid or received.
The Max Gain The profit of the stock +/- the premium for the optoins. The profit on the stock will be the strike price of the call option minus the purchase price of the stock (as you will be exercised and deliver at the strike) plus the net premium paid or received.
Characteristics
As you can see from the above payoff chart, a collar behaves just like a long call spread.
It is suited to investors who already own the stock and are looking to:
- increase their return by writing call options
- minimize their downside risk by buying put options
Covered calls are becoming very popular strategy for investors who already own stock. They sell out-of-the-money call options at a price that they are happy to sell the stock at in return for receiving some premium upfront. If the stock doesn't trade above this level, the investor keeps the premium.
The problem with covered calls is that they have unlimited downside risk.
The solution to this is to protect the downside by buying an out-of-the-money put.
This increases the cost as you will have to outlay more to purchase the put and hence lowers your overall return.
Collar Greeks
Delta
Gamma
Vega
Theta
23 Comments
Mc Clane December 30th, 2012 at 2:11pm
My comment might be a little off the subject but I thought this might be the best place to ask. I have millions of penny stocks in about 8 companies (OTCBB & pinksheets)I've been holding the stocks for over 7 years now and none of them have had impressive returns therefore wouldn't like to sell'em.. I have the understanding that OTCBB & pink sheets stocks don't trade options. My question is what can I do with these? Is there a strategy fit fot these kind of situations? Greetings!
Peter October 29th, 2012 at 4:41am
Hi Arthur,
Apologies for the delay in responding!
1) It is risky in the sense that you have no upside or downside protection. But this is no more of risky position than holding the stock outright as your position resembles a synthetic long stock.
2) No, you will "add" to the risk if you "bought" the stock. If you "sold" the stock you would be short a collar.
3) A Long Synthetic.
4) Nothing if you bought, but if you sold the stock it would be a Short Collar.
5) You could look to buy the stock and the sell the call and buy the put for a Long Collar.
Arthur October 9th, 2012 at 3:30pm
Hey,
I bought a Nov 2.5 Call and sold a Feb 5 put, both on BSDM (stock closed at 2.02 today). Got a few of questions:
1) Is this an unreasonably risky trade?
2) Can I mitigate the risk by buying the stock at say, $2.08?
3) What strategy is it called without the stock?
4) What strategy is it called if I buy the stock?
5) Is there a better way to have done this?
Thanks for your responses (I just discovered your site today... I would have made a better trade had I found it earlier). Great site!
Peter August 13th, 2012 at 7:48pm
Hi Marian,
If you "must" protect the total $1,000,000 then best not to trade at all - leave the money in the bank and earn interest.
If you wanted to put on a collar you will need to buy some stock first and then also sell call options to offset the purchase of the puts. However, with a collar you will still have some downside risk to consider, which is the maximum loss on the trade if the market sells off.
If you want to buy stocks and are looking for downside protection then you could also look at a Protective Put.
marian August 11th, 2012 at 11:06am
Hi Peter,
Suppose I had $1,000,000 and in 1 year I still want to have at least the same amount. If possible, I want to make some profit but I must protect those $1,000,000. Would you recommend a collar option strategy in this case?
Thanks for your help!
Peter April 25th, 2012 at 10:26pm
Yes, I see that the description above can be a bit confusing. I've modified it so it is a little clearer.
In your example above, if the stock is below K1 then your loss will any loss on the stock +/- the premium for the option legs. So, the purchase price of the stock minus the K1 (as you will exercise and sell the stock at that price) plus premium received (or less premium paid).
kamal April 24th, 2012 at 4:52am
Hi Peter,
First thanks for this very helpfull website.
I can't understand when you say that the maximum loss would be : "Limited to the difference between the two strikes less the net premium paid or received less the loss on the stock leg".
If you're long the stock S and long OTM put with strike K1 and short OTM call with strike K2 as such k1 < k2.. when your stock price is less than k1 then your PL would be K1 + premium paid/received for both call and put. is it right? or am i missing something here?
Thanks for your reply.
Peter November 17th, 2011 at 4:57am
The graph is correct - a collar just has a similar payoff profile as a bull spread.
You can use my option pricing spreadsheet and build the individual legs to verify if you like.
Sam November 17th, 2011 at 4:41am
The graph is wrong, this is a bull spread that we can see on it and not a collar
Peter June 22nd, 2011 at 5:37pm
Hi Pierre, yes, both have the same payoff profile, however, the prices paid for the options and hence the max profit/loss will be different.
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