Collars
What is a collar?
A collar is a position similar to a covered call except that with a collar you purchase an otm put for downside protection.
example:
Suppose the following situation existed.
XYZ Stock Price: 58.00
XYZ March 60 Call: 5.00
XYZ March 50 Put: 2.00
A Collar could be established by buying 100 shares of XYZ, selling the 40 Call, and buying the 35 put.
The cost would be: -3800 cost of 100 shares + 200 of call premium - 125 cost of put = $3,725 Debit.
Results at expiration
Below is a table consisting of the possible outcomes at March expiration for this trade.
Please note the color scheme for losses, gains, and breakeven.
| Collar Example: Buy XYZ at 58, Sell Call at 5, Buy Put at 2 |
|
More than $800 |
$300 to $800 |
$300 |
-$300 to +$200 |
$200 |
|
Gain $ for $ |
$200 |
$200 |
$200 |
$200 |
|
$500 |
$500 |
$500 |
$500 |
$500 |
|
$500 |
$500 to Even |
Breakeven |
Even to $500 |
$500 |
XYZ Above 60 at expiration
Similar to a covered call, if the stock is above the call strike, I would be assigned and my shares would be sold at 60.
The Put would expire worthless, and I would keep the $500 premium from the sale of the call.
My profit would be $200 for the stock + $500 for the call premium - $200 for the cost of the put = $500 gain.
XYZ 55 at expiration
Again, the probability of XYZ being exactly 55 at expiration is small, I want to mention it because it is the breakeven point on this particular trade.
The stock would have a loss of $300 due to the drop from 58 to 55 a share.
The Put would still expire worthless for a loss of $200.
The Call would expire worthless and I would keep the gain of $500.
The total profit would then be zero, a breakeven
XYZ 50 or Lower at expiration
This is the place where losses where occur, HOWEVER, the losses will be limited unlike a covered call position.
If the stock is below 50, the put will be in the money and at expiration will be worth however many points XYZ is below 50, thus limiting the loss.
The stock will be at a loss of $800 or more.
The call will expire worthless and I will gain the $500.
The total loss will be limited to $500 thanks to the purchase of the put
Chart of outcomes at March expiration
Here is a chart of what a collar trade looks like. ALL collars will have a similar appearance. Limited upside potential and limited downside potential.
Chart made with Microsoft Excel®
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