Collar Option Spread

The Collar option spread is a way to utilize the covered call strategy. Only this strategy looks at the big problem of covered calls, the down side.

With an option collar you buy the stock and sell a call on it. You also buy a protective put on the stock to limit the downside.

So say we find a stock that is trading at $60, we buy it and sell the $60 call on the stock for $4 and buy the $55 put for $2.

Max Profit

The collar option spread has a max profit potential just like the covered calls strategy. In the above example the most you can possible make is $2 from the trade or 3.33%, in that 1 month.

Max Loss

Unlike covered calls your max loss is significantly reduced by buying the put. If the stock suddenly falls down 10% or so you have a huge loss potential. Because an option collar spread utilizes the protective put strategy your loss is lowered.

In the above example you bought the stock at $60 and bought the $55 put, so the worst price you could sell the stock for is $55, which would give you a max loss of $5 or $3 when you consider the profit.

What could happen

There are 3 possible outcomes for this trade.

1. We could get called out. If the stock goes up we will get called out, make our full profit and have no shares of stock left.

2. The stock stays between $55 and $60. If this happens the options expire worthless and we keep the stock. We might look at making another collar trade next month.

3. The stock falls below $55. In this case we realize our max loss, but it is smaller than if we were to just buy the stock.

Long term collar option spreads

Many people who trade collars do so in a longer term period. They buy the stock, buy a put 6 months or so out, and then sell calls on the stock every month.

For example say we buy the same stock at $60 but this time we bought the $55 put 6 months away for $6. We also sold the $65 front month calls for $3.

In this case we are losing money up front, but we can sell a new call on the stock every month for 6 months, hmmm. We could still stand to gain money by the time the trade is over.