Objective: The objective of Options Collar Strategy is to profit from upward movement in the chosen underlying while insuring against downside losses AND at least partially paying for that insurance
Definition: An Options Collar consists of purchasing 100 shares of stock. You can insure that purchase by also buying a put option at a strike price equal to or lower than the current stock level. Then, you will sell a call option at a higher strike than the put to partially or wholly finance the put premium. For example, you would buy stock for $100 per share, buy ONE 100 put for $2 or $200 per contract, and sell ONE 105 call at $1. This formula works regardless of the underlying’s price.
Maximum Risk: To find maximum risk, you take the original purchase price of the stock and SUBTRACT the put strike. Then, you ADD the premium paid from the put purchase, AND SUBTRACT the premium collected for the sold call option.
Maximum Profit: To find maximum profit, start with the short call strike and SUBTRACT the original purchase price of the stock. Then, SUBTRACT the long put premium, and ADD the premium collected for the short call option. [e.g. ($105 – $100 – $2 +1) = $4]
Benefits: Options Collars represent the evolution of the union between the married put strategy and the covered call strategy. They allow traders to benefit from upward movement in the stock while protecting them from large losses to the downside AND helping to pay for their downside insurance.
Break-even (B/E): The B/E is the price the stock must remain above at expiration for the trade to breakeven. You find the B/E of a Collar by starting with the stock purchase price, ADDING the premium paid for the put option, and then SUBTRACTING the premium collected for the short call option. For example, when you buy stock for $100 and the 100 put for $2, and you sell the 105 call for $1, then the B/E would be $101 (100 stock purchase price + $2 debit from long put – $1 credit from short call).
There is no time value left when an option is at expiration. Therefore, if the stock closes lower than the B/E at expiration, then a loss will occur. If the stock closes above the B/E at expiration, then a profit occurs. The chart below illustrates what happens at expiration at various stock prices:
|
Collar Profit and Loss |
||||||||||
|
Stock Long Stock Price at 100$ |
+ |
Long 100 Put |
– |
Short 105 Call |
– |
Net Option Debit |
= |
Profit or Loss |
||
| 150 $50.00 | + | $0.00 | – | $45.00 | – | $1.00 | = | $4.00 | ||
| 115 $15.00 | + | $0.00 | – | $10.00 | – | $1.00 | = | $4.00 | ||
| 110 $10.00 | + | $0.00 | – | $5.00 | – | $1.00 | = | $4.00 | ||
| 107 $7.00 | + | $0.00 | – | $2.00 | – | $1.00 | = | $4.00 | ||
| 106 $6.00 | + | $0.00 | – | $1.00 | – | $1.00 | = | $4.00 | ||
| 105 $5.00 | + | $0.00 | – | $0.00 | – | $1.00 | = | $4.00 | ||
| 104 $4.00 | + | $0.00 | – | $0.00 | – | $1.00 | = | $3.00 | ||
| 103 $3.00 | + | $0.00 | – | $0.00 | – | $1.00 | = | $2.00 | ||
| 102 $2.00 | + | $0.00 | – | $0.00 | – | $1.00 | = | $1.00 | ||
| 101 $1.00 | + | $0.00 | – | $0.00 | – | $1.00 | = | $0.00 | ||
| 100 $0.00 | + | $0.00 | – | $0.00 | – | $1.00 | = | -$1.00 | ||
| 99 -$1.00 | + | $1.00 | – | $0.00 | – | $1.00 | = | -$1.00 | ||
| 98 -$2.00 | + | $2.00 | – | $0.00 | – | $1.00 | = | -$1.00 | ||
| 95 -$5.00 | + | $5.00 | – | $0.00 | – | $1.00 | = | -$1.00 | ||
| 50 -$50.00 | + | $50.00 | – | $0.00 | – | $1.00 | = | -$1.00 | ||