What is a Collar?
How Does a Collar Option Strategy Work?
In a collar, the investor has a long position in a stock, so he benefits when the shares increase in price. To implement a successful collar strategy, the strike price for the call he's selling needs to be above that of the put he's buying. Both options should also have the same expiration date.
For example, say you own 100 shares of Company XYZ at $45. To implement a proper collar, you buy a put with a strike price of $43 and sell a call with a strike price of $47. The expiration date on both options is the same.
If XYZ rises above $47, the buyer of the call will exercise his option, and you must sell him 100 shares of XYZ at $47, even if shares are selling for more than that in the market. Regardless of how high the price goes, you make a $2 profit.
If Company XYZ falls below $43, then you only lose $2 a share, because you have the right to sell 100 shares of XYZ at $43, even if they are trading below that price.
If XYZ is trading between $43 and $47 when the expiration date arrives, the options expire worthless, and you keep your shares at the current market value.
Note that the collar ensures you can't lose or make more than $2 on the trade no matter how high XYZ rises or how low it falls. You have a stop on the upside, but you also have a stop on the downside.
Why Does a Collar Matter?
Collars are a conservative strategy and are generally implemented to protect profits, not generate them. Investors need to always be assessing the risk/reward ratio of every position they're considering. Fortunately, the risk/reward scenario for collars is clear: It's low risk, low reward.
On the other hand, if your threshold for risk is low, collars are a fine way to protect your portfolio from the unexpected.
[Learn more about collar option strategies in the InvestingAnswers feature: Add Protection Against a Market Downturn With Collar Options.]
Personalized Financial Plans for an Uncertain Market
In today’s uncertain market, investors are looking for answers to help them grow and protect their savings. So we partnered with Vanguard Advisers -- one of the most trusted names in finance -- to offer you a financial plan built to withstand a variety of market and economic conditions. A Vanguard advisor will craft your customized plan and then manage your savings, giving you more confidence to help you meet your goals. Click here to get started.
Read This Next
We saw the effect of foreign policy on both the U.S. dollar and the New York Stock Exchange when the EU...Read More →
The history of investing is rife with the ...Read More →
Imagine a country where everyone owns everything outright -- cars, houses, fishing boats, flat-screen TVs. There are no mortgages and no credit card balances in this...Read More →
Booking travel is so easy to do, yet all too often we wind up spending more than we wanted. Thank fee-happy airlines for that -- there's no limit to what they'll charge for, from meals to...Read More →