1
Options Collars
Steve Meizinger
ISE Education
Education@ISEoptions.com
2
Required Reading
For the sake of simplicity, the examples that follow do not take into
consideration commissions and other transaction fees, tax
considerations, or margin requirements, which are factors that may
significantly affect the economic consequences of a given strategy.
An investor should review transaction costs, margin requirements and
tax considerations with a broker and tax advisor before entering into
any options strategy.
Options involve risk and are not suitable for everyone. Prior to buying
or selling an option, a person must receive a copy of
CHARACTERISTICS AND RISKS OF STANDARDIZED OPTIONS.
Copies have been provided for you today and may be obtained from
your broker, one of the exchanges or The Options Clearing
Corporation. A prospectus, which discusses the role of The Options
Clearing Corporation, is also available, without charge, upon request
at 1-888-OPTIONS or www.888options.com.
Any strategies discussed, including examples using actual securities
price data, are strictly for illustrative and educational purposes and are
not to be construed as an endorsement or recommendation to buy or
sell securities.
3
Refresher
» Put options give holders the right to sell the stock
at the strike price, but not the obligation, for that
right they pay a premium
» Puts can insure portfolios although the cost of
the put must be considered
» Call options give writers the obligation, but not
the guarantee to sell the stock at the strike price
for that obligation they receive a premium
4
Altering risk/reward
» Is there a way to insure your stock/portfolio
without buying the puts outright?
5
Option Collar
» The Option Collar strategy is a protective strategy
that allows investors to limit their downside risk
by selling an upside call option
» Normally this strategy is employed subsequent to
the purchase of the stock, thereby protecting the
sale price of the stock
6
Definition of Option Collars
» The purchase of a put and the simultaneous
selling of a call
» The goal of an option collar is for downside
protection with a minimal cost
» The economics of the trade depends on the price
of the stock in relation to the downside put and
the upside call sold and also the implied volatility
of each
7
Construction of a collar
» XYZ stock is trading 46.90 and investor is
nervous about the next 53 days and a possible
drop in the stock but does not want to sell the
stock
» Action: Buy 53 day 40 strike put ($.75) and sell 53
day 55 strike call ($.60) for a total debit of $.15
8
Rights and Obligations
» Investor has the right to sell the stock with the
purchase of the put option at $40 until expiration,
53 days in this example
» Investor has the obligation to sell the stock at
$55 if the call purchaser chooses to exercise any
until expiration (53 days)
9
Example of the collar at expiration
Stock at
Expiration
Cost of
Collar
Value of
55 Call
sold
Value of
40 Put
bought
Stock
relative
to 46.90
Profit
&Loss
60
-.15
-5
0
13.1
7.95
55
-.15
0
0
8.1
7.95
50
-.15
0
0
3.1
2.95
46.9
-.15
0
0
0
-0.15
45
-.15
0
0
-1.9
-2.05
40
-.15
0
0
-6.9
-7.05
35
-.15
0
5
-11.9
-7.05
30
-.15
0
10
-16.9
-7.05
25
-.15
0
15
-21.9
-7.05
10
Collar risk-reward prior to expiration
11
Risk-reward at expiration
12
Components of collar
» Covered call (long stock with a call option sold),
in this case 55 strike covered call in conjunction
with a downside put for protection
13
Advantages of Collars
» Guarantees minimum selling price during the life
of the collar
» Relative low cost compared to outright put
purchases
» Ownership of stock is maintained until exercise
or assignment even though stock declines are
being protected
14
Disadvantages of a Collar
» Investor caps further stock appreciation to the
upside call sold
» Modest downside risk is maintained although
limited to the put strike held
15
Collars act like spreads?
» If the call and put are the same expiration date the
collar acts like a spread with clearly defined risk
and reward tradeoffs
» Collars are a synthetic long call vertical
» A minimum and maximum value is created until
expiration of the collar
16
Why use collars?
» Bullish on a stock long term although “nervous”
about the stock in the shorter term
» Do not want to pay for the puts outright, willing to
finance them with the selling of call
17
Options are about risk and return
» Collars are not free
» Question: Would you be willing to have your
stock called away at the strike price?
18
Concentrated stock positions
» If an investor has a large position in one, or a few
stocks, collars can help reduce risk
» The selection of the long put and the sold call
allow an investor to select their own risk reward
tradeoffs while controlling risk
19
Outcomes: Do Nothing
» Stock is not collared- Investor would continue to
have unlimited upside with substantial downside
risk
20
Outcomes: Collar with Call assigned
» Stock finishes in the money at expiration and
investor sells their stock at the upside call strike
price (best scenario), sell stock at $55
» Maximum value realized under collar strategy
21
Outcomes: Put exercised
» Stock falls and investor can exercise their put
option, selling stock at the lower put strike price,
sell stock at $40
» Minimum value created under collar strategy
22
Outcomes: Neutral stock movement at expiration
» Stock ownership is maintained with a small
increased cost depending on initial debit amount
» Further consideration must be given to possibility
of reentering the position in the future
» Alternatively the collar can be rolled forward to
future months in the last couple of days prior to
expiration if there is any time premium left in the
shorter term options
» Neither minimum nor maximum realized
23
Considerations for Collars
» Strike price- Must balance risk and reward and
recognize your rights and obligations with the
varying strike prices
» Time- Investors must choose the time frame they
would like to protect and select that month
24
Considerations for Collars
» Rolling- As time moves forward option theta
reduces the option time values, investors can
choose to roll your options to further out months
» Volatility- Option skew can sometimes alter these
trades, option markets are efficiently priced and
“price in” potential rapid price drops by allowing
for higher put implied volatilities
25
Option Skew??
» Option skew- Correlation between volatility and
direction
» Normally volatility increases at lower prices, but
by how much?
» Also called “fat tails” especially to the downside,
stocks tend to drop faster than they rise
26
Concerns
» Are you really willing to sell your stock at the call strike
price or are you just trying to finance the put?
» Put skew develops in many stocks that hurts the
economics of the trade. This creates a challenge as puts
“tend” to trade at higher to slightly higher prices than calls
based on implied volatilities (of course many professionals
would contend that option pricing is very efficient)
» Skew is mostly determined by supply and demand factors
from the marketplace
27
Summary
» A long underlying position can be protected using the long
put and short call position
» The selection of the strike prices for both the put and call
depends on the amount of protection required
» Collars limit your upside but protect the downside
» The collar is a cheap protection method although this
cheapness must be balanced against the obligations
undertaken
28
ISEoptions.com
29