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
Sarish April 28th, 2009 at 4:18pm
What does OTM stand for? Thanks for your response:)
Admin August 23rd, 2008 at 6:28pm
Yep, you're right Nitesh. I've changed the typo as indicated.
Nitesh August 22nd, 2008 at 2:32am
Under components you say, that we should long OTM Put option, however under characteristics is mentioned that it is ideal for the investors who own the stock and are looking for minimise their downside risk by WRITING put option. I guess instead of WRITING put uption it should be buying the put option.
Thank you
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