Collar

Article contents



At a glance



Setting up the strategy


  1. You buy or own the underlying stock.

  2. Buy one protective put option.

  3. Sell one call option with the same expiry date as the put option.
Ideally, you want to set up both options to be slightly out-of-the-money.

Who should run this?


Intermediate to advanced traders.

Margin requirements


Learn more about Questrade’s option margin requirements.

Strategy overview



A collar is an options strategy in which a trader holds a position on the underlying stock and simultaneously buys a protective put while selling a call option against the same stock. In most cases, both options expire within the same month.

This strategy protects the trader against the sharp decline of the share price while still earning an option premium from writing the covered call.

As the seller of the call option, you are obligated to sell the stock you already own at the strike price if the buyer exercises the call option. Likewise, the seller of the put option has the obligation to buy the asset at the strike price if you exercise the put option.

Market outlook


  • Neutral

Strategy benefits


  • Receive income from the option premium when you sell the call option.
  • Offset losses if your stock depreciates in value.
  • Maximum loss is limited.

Strategy downsides


  • May lose your stocks if the stock value rises beyond the strike price of the option.
  • Limited profit potential.

Collar example



Scenario


You buy100 shares of ABC stock currently valued at $20 per share ($2000) in February. To protect yourself against the potential sharp decline of the share price, you purchase a $17 out-of-the-money (OTM) put option for $100 (1.00 x 100 shares = $100) that expires in January of next year. To complete the collar, you simultaneously sell a $30 OTM call option for $250 (2.50 x 100 shares = $250) that also expires in January of next year.

As the buyer of the put option, you have the right to sell the stock at a $24 strike price before the option expiry date. 

Your initial investment would be $2000 (100 shares) plus $100 for the put option, minus $250 for selling the call option. This would make your total investment $1850.
This strategy means that you:

  • as the buyer of the put option, have the right to sell the shares at $17 before the expiration date
or

  • as the seller of the call option, have the obligation to sell the shares at $30 before the expiration date.

Possible results


  1. ABC shares rise to $32 on the expiration date, meaning it’s up 12 points from the $20 original value. Since the call option’s strike value ($30) is lower than the $32 trading value, the call is exercised by the buyer. Although you miss out on an additional $200 profit ($2 x 100 shares), your total profit would still be $1150 ($3000 - $1850 initial investment).

  2. ABC shares drop to $15 per share on the expiration date, losing $5 off its original value, resulting in a $500 loss. However, since you purchased a protective put option, you have the right to sell the shares at $17 per share, meaning your loss on the shares would be capped at $300. Since you also received a $250 option premium but paid a $100 premium to buy the protective put, your total loss would only be $150 ($300 loss + $100 put premium – $250 call premium).

Profit and loss explained



Maximum profit


  • Maximum profit = [(strike price of call option – original purchase price of stock) x number of stocks) + [(call option premium – put option premium) x number of contracts x 100]

Maximum loss


  • Maximum loss = [(original purchase price of stock – strike price of the put option) x number of stocks] + [(put option premium – call option premium) x number of contracts x 100]

Break-even at expiration


  • Break-even point = original purchase price of stock + put option premium – call option premium

Sample calculations



  • Stock value at start of strategy: $20
  • To execute the strategy: Buy 100 shares for $2000, Buy $17 out-of-money put option for $100,
    Sell $30 out-of-the-money call option for $250
  • Result: $1850 net debit

Stock price at expiration Profit and loss calculations 
$15 $20 (original share price)
-$17 (put option strike price)
+$1.00 (put option premium)
-$2.50 (call option premium)
x 100 (number of shares)
= $150 loss
$32 $30 (strike price of call option)
-$20 (original purchase price)
+$2.50 (call option premium)
-$1.00 (put option premium)
x 1 (number of option contracts)
x 100 (number of shares)
= $1150 profit



Note
: commission fees are not included in the above calculations.


Payoff diagram






Creating a collar







Standard order details

Order detail

Description

Symbol lookup field

Click  and change the mode to . Then enter the symbol you want to buy or sell. The default expiration date, strike price, and strategy appear. 




Tip: click the Option tab to view a more detailed option quote.

Modify the expiration date, strike price, and option strategy accordingly. For more information, see Elements of an option quote.
Action

The buy or sell action is set for you when you select the strategy type.

Qty

Select a value using the arrows , or enter a value manually.

Note: by default, the quantity will be populated with the value set in your user preferences.
Order type Select the type of order you want to submit. When creating strategy orders, only Limit or Market order types are available. For more information, see Order types.

The limit order type requires you to fill in additional fields. Refer to the table section below for details.
Duration

Select a duration to specify how long the order should remain active. For more information, see Order durations.

Route Select a route or leave the selection at Auto to let the platform determine the best one. Canadian routes will be listed for Canadian symbols and U.S. routes will be listed for U.S symbols.
Sub-route

This field will be filtered according to the route selection. It indicates where you prefer the order to be executed. Leave the selection at Auto to let the platform determine the best route.

Note: sub-route selection is only available for Canadian symbols.
Order type-specific details
Limit price Enter your limit price:

  • To have the price fluctuate according to real-time data, select . The icon changes to a lock icon , which locks the limit price. Once locked, use the refresh button to automatically update your limit price.
  • To choose a custom price, select .
Note: if real-time market data is not available, the limit price will be blank and the float limit icon will be unlocked.






Note: the video tutorial above shows how to create a collar strategy using IQ Edge; however, the principles are the same for IQ Web.
Tip: for an optimized viewing experience, watch the video on YouTube in full 720p HD. To open the video in YouTube, click the YouTube button in the bottom right corner of the video window and select the change settings icon to modify the video quality.


All content in the Exchange, whether provided by Questrade or created by the community members, is for informational purposes only and does not contain advice or recommendations on behalf of Questrade Inc. Use of this site is subject to the terms of service and user posting rules.