We will use them to understand a point about the greeks later. Let’s look at the three collars pictorially. In the examples below, the expiration date is October 9 th, 2020. To set up a collar, you must write a call above the current price and buy a put below the current price.īoth options should have the same expiration date. premium paid for put and proceeds received from call should offset each other (as much as possible). The goal is to enter a zero cost collar i.e.
Let’s look at three different collar trades he can enter and discuss the differences. The investor believes there is more room for the stock to run up but wants to safeguard the position against a downturn.
PAYOFF VS PROFIT OPTIONS HOW TO
Let’s look at the mechanics of the trade and understand how to set it up.Ĭonsider the investor who bought shares of Uber at its all time low of $14.Īs of September 16 th, 2020, it is trading at $37.66. You want to continue owning the stock for its dividend.Your view on the stock is bullish, but you are nervous it will tank after lockup expiration.You are holding IPO shares and the sale is restricted by lockup agreement.Protection is costly so you can reduce the cash outlay by writing a call.You don’t want to sell your position but want downside protection.Your position has a low tax cost basis and selling the stock will create a huge tax bill.Typically, investors step into a collar after their stock holdings have appreciated and they want to protect their unrealized profits.īut that is not the only reason.
We can apply the same concept in the world of stock holdings.īefore we begin, let me emphasize that one can place a collar at the same time as entering the stock position, or simply step into a collar at a later point.
PAYOFF VS PROFIT OPTIONS SERIES
It is commonly used in a corporate finance setting to hedge interest rate risks on floating rate assets.įor example, when an institution that has an investment portfolio of floating rate securities, it can hedge interest rate risk by buying interest rate floors (a series of puts) and paying for it by writing a cap (series of calls). Think of it as running a covered call with a long put, or protective put with a short call. In short, you are long stock, long put, and short call at the same time.
You simply purchase a put on the underlying stock and finance it with the sale of a call. The collar strategy is an option strategy that allows the investor to acquire downside protection by giving up upside potential on a stock that he currently owns.