Collar Option Strategy

 

A collar options strategy that consists of buying or owning the stock, and then buying a put option at strike price A, and selling a call option at strike price B. An options trader who enters this strategy wants the stock to trade higher and get called away at the call strike price B. However, also wants protection in case the stock price falls below strike price A, giving the them the right to exercise the option contract and sell the stock if it does.

A collar option is essentially what would happen if a trader wants to run a covered call and a protective put at the same time. This strategy is usually executed when the investor wants downside protection but does not want to pay for it. So to cover their cost, they limit their upside potential in exchange for capping their downside exposure. This strategy may be applied to both short-term and long-term positions.

When to Use a Collar

An investor should consider using a collar if they are bullish on the stock for the long run, but are concerned about short-term downward movement. Such things might include uncertainty about earnings, a world health pandemic, or any other short-term market uncertainty.

An investor may also use a collar when they have significant gains in stock that they wish not to risk. Here an investor can implement a collar option strategy to protect the profits they have already generated.

To implement the collar, the investor purchases an out of the money put option, which protects against a price drop in the stock. They then offset the premium paid for this put option by selling an out of the money call option, expiring in the same month against it.

The collar is a highly useful strategy in a volatile market, it protects the investor for little to no cost, giving them the ability to limit their potential loss if the stock trades down, in exchange for limiting their potential profit. Because the call option is sold above the stock price, there is still room for the investor to profit, while at the same time, easing their concern with the stock trading down.



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