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2. Basics Concepts – Collar
Proficiency -
Intermediate
Direction –
Bullish
Asset Leg –
Long Stock + Long
Put+ Short Call
Max Risk -
Limited
Max Reward -
Limited
Capital Gain
Strategies
3. Description – Collar
The Collar is similar to a Covered Call but typically works over
a much longer time period and involves another leg—buying a
put to insure against the stock falling.
The effect is of buying a stock, insuring against a down-
move by buying puts, and then insuring the trade by selling
calls.
Buy stock ➞ Buy asset
Buy puts ➞ Insure it from falling
Sell calls ➞ Finance the insurance
4. Description – Collar
Buy the stock.
Buy ATM (or OTM) puts.
Sell OTM calls.
The closer the put strike is to the price you bought the stock for, the
better insurance you’ll have if the stock falls. However, the better
insurance you have in that regard, the more it will cost you!
5. Steps to Trading a Collar
Steps In
Try to ensure that the trend is upward and identify a clear area of Support.
Steps Out
Manage your position according to the rules defined in your Trading Plan.
At expiration, you hope that your call will be exercised and that you’ve made
your maximum profit.
If the stock remains below the call strike but above your stop loss, let the call
expire worthless and keep the entire premium.
The point of a Collar is that you set the put strike at or above your stop loss,
creating a minimum risk trade. Therefore, you are at liberty to keep the
position until expiration.
6. Context - Collar
Outlook
With Collars, your outlook is conservatively bullish.
This is supposed to be a very low-risk strategy.
Rationale
To execute a long-term trade that is inherently low-risk.
You will have to use online tools to determine how little risk you’re
going to take.
Long-term trade that takes money out of your account, there is
“opportunity cost.”
7. Context - PutRatio Backspread
Net Position
This is a net debit trade because money will come out of your
account to pay for the stock.
If you select the right strike prices for the bought put and sold call,
you may even be able to execute this trade with no risk at
expiration, even though money has been debited from your account
in order to make the trade.
If the stock falls, then the ATM put (your insurance) will rise in
value, and you will retain the premium received by having sold the
OTM call.
This combination will offset the fall in value of the long stock.
8. Context - Collar
Effect of Time Decay
Time decay will be helpful with the sold call; it will be unhelpful to
the bought put and will have no effect on the stock you have
bought.
The net effect is that time decay is helpful here when the position
is profitable and harmful when the position is loss-making.
Time Period to Trade
You will be safer to choose a Longer time to expiration
Breakeven = [Stock price - call premium + put premium]
9. Exiting the Trade - Collar
Exiting the Position
If executed correctly, you will not need to exit this trade early
because there should be very little risk.
Advanced traders may leg up and down as the underlying asset
fluctuates up and down.
In this way the trader will be taking smaller incremental profits
before the expiration of the trade.
Mitigating a Loss
This shouldn’t be an issue with the Collar!
10. Advantages and Disadvantages
Advantages
Give yourself maximum protection against a fall in the underlying
stock price.
With volatile stocks, you can create a very low risk or even risk-free
trade.
You can create a high yield on risk.
Disadvantages
Works best for long-term strategies (over one year), so it is slow.
Maximum upside only occurs at expiration.
Creates only a low reward on capital expended.