Collars

Overview:

The collar strategy is a combination of a protective put and a covered call, traded alongside a long stock position. The covered call typically helps pay for the protective put. The strategy is employed by initially owning the underlying stock and then simultaneously purchasing an out-of-the-money put option and selling an out-of-the-money call option with a higher strike than that of the purchased put. Both options will expire in the same month.

Main Use:

1. An investor typically invests in a collar when the investment in the underlying stock has earned money and the investor would like to protect his or her returns. The investor will sell the call option similar to a covered call to help off-set the cost of the protective put, which protects existing returns from the long-stock trade.

Profit / Loss Collar:

The below graph is a profit / loss graph of a collar on Cree Inc. (CREE) using the OptionsHouse Profit/Loss calculator (available to customers with a free virtual trading account).

The investor owns the underlying stock. The current stock price is $57. A January put option with a strike price of $50 was purchased for $6.40 and a call option with a strike price of $65 was sold for $6.40. The breakeven point is $57. The investor will make money as long as the underlying stock price stays above $57. Maximum profit is limited to $8, or the 65 strike minus the current stock price.  Maximum potential loss is limited to $7, which is the current stock price minus the 50 strike.