The Collar
Risk: limited
Reward: limited
General Description
The collar entails buying an out-of-the-money put and selling an out-of-the-money call of a stock you own and want to hold.
The Thinking
You own a stock and would like to hold it but would like to protect yourself to the downside. Essentially you are buying a put to protect yourself in case the stock drops, and you sell a call to help pay for the put. The put will protect you on the downside, but if the stock rallies you won't participate beyond the strike price of the call.
Example
Let's say you are the proud owner of 100 shares of NTAP which is currently trading @ 12.84. You plan on holding the stock but think it may fall in the short term. Buy the (1) 10 put for $0.60 ($60.0) and sell the (1) 15 call for $0.80 ($80.0).
The call you sold pays for the put (i.e. the call pays for downside protection). If the stock drops below 10 you will lose, but at least your loss will be minimized by the put option. If the stock rallies, you will make money on the long stock position, but above 15 the long stock position will be canceled out by the short call position.
|
