collar

Equity Collar Hedge

for stocks

An equity collar is generated by selling an equal number of call options and buying the same amount of put options on a long stock position. It protects the downside risk of a stock position while limiting the upside potential.

Holding shares of the underlying stock while simultaneously buying protective puts and selling call options against the holding one creates a collar. The puts and calls are both out-of-the-money options having the same expiration.


Suitability:

savvy to pro investors

Savvy Investors

This hedge requires a combination of option calls and puts and therefore is only suitable for savvy investors.

Protection:

great

Great

Protection is robust at the expense of profit potential.

Cost:

zero to low

Zero to Low

Many times, there is no cost in generating collars due to premiums offsetting expenses.


Example:

An investor owns 100 shares of XYZ stock that is trading for $48 in June. They create a collar by writing (selling) a JUL 50 covered call for $2 while simultaneously purchasing a JUL 45 put for $1.

The total investment is $4700 based on the following:

  • -$4800 for the 100 shares of XYZ
  • -$100 for the put
  • +$200 for selling the call option

On the expiration date, the stock loses 5 points, settling at $43. Now the strike price of $50 for the call option is higher than the trading price of the stock. Thanks to the JUL 45 protective put, they sell for $4500 instead of $4300, limiting the loss to just $200.

If the stock gained 5 points on the expiration date, reaching $53, we then have a different scenario. Now the strike price of $50 for the call option is lower than the trading price of the stock. The investor sells his shares for $5000, resulting in a profit of $300 ($5000 minus $4700 original investment).


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© 2020 Todd Moses

The strategies discussed are for illustrative and educational purposes and are not a recommendation, offer, or solicitation to buy or sell any currency or to adopt any investment strategy. There is no guarantee that any strategies discussed will be useful. Todd Moses is not a licensed securities dealer, broker, or US investment adviser or investment bank.