Options Trading Strategies Collar

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Options Trading Strategies

Collar

The collar is best suited for those who are bullish but a bit anxious about the stock falling. The setup for a collar involves a long position in the underlying stock, a put option at a specified strike price X and a short call option at a specified strike price Y. For this strategy, the stock price would be between strikes X and Y, and the strike price X is less than strike price Y.

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A trader, who is bullish in nature but has a very low risk appetite and wants to mitigate his risk will implement the Collar Strategy. Collar involves buying of stock in either Cash/Futures Market, buying an ATM Put Option & selling an OTM Call Option. The expiry dates of the options should be same. Here the long position will make profits if things go as per plan i.e. stock gains.

Think of a collar as combining a covered call with a protective put. Now, the covered call is simply a long position in the stock and a short position in a call option at a strike price above the stock price.

With a collar, you have limited downside risk. However, you have limited upside potential. There are two break-even points for a collar strategy. If you implement this trade for a net credit, the break-even is the current underlying’s price less the net credit received. On the other hand, if the trade is implemented for a net debit, the break-even point is the current stock price plus the net debit paid.

Since they are willing to risk sacrificing gains on the stock above the covered call's strike price, this is not a strategy for an investor who is extremely bullish on the stock.

The put option will cover the losses if things go in the opposite direction. The profits will be limited on account of the sale of an OTM Call Option.

Break Even Point

Underlying stock purchase price + Net debit

Underlying stock purchase price - Net credit

The maximum profit of a collar is equivalent to the call option's strike price less the underlying stock's purchase price per share. The maximum loss is the purchase price of the underlying stock less the put option's strike price.

Risk: Limited

Reward: Limited

Actions

Buy stock in Cash/Futures Market

Buy ATM Put Option

Sell OTM Call Option

Collar Option Strategies Example

Mr. G is bullish on NIFTY and expects it to rise, but also very conservative in nature. He deploys Collar Strategy where he buys the underlying stock in the futures market, sells an OTM Call Option & buys ATM Put Option.

Now his net position is safe from adverse movements in any direction either down or up. Lot size of NIFTY is 75.

He buys one NIFTY futures at 11300, sells one 11400 OTM Call Option at a premium of Rs. 24 & buys one 11300 ATM Put Option for a premium of Rs. 75.