A collar is a spread strategy where you simultaneously purchase a protective put and write a covered call on stock you already own. If you hold a stock whose price has risen sharply, a collar can help you protect those gains against a future drop in price. Moreover, writing a covered call helps offset the price of buying the protective put, making it relatively inexpensive to protect your profit.
For example, say you bought 100 shares of NRQ stock at $20 three years ago, and its current market price is $35. If you purchase a 30 put, you'll have the right to sell those shares at $30 before expiration, locking in a $10 profit on each share, or a total of $1,000. In this scenario, the price of the put cost you $300, or $3 per share.
To complete the collar, imagine you also write a 40 call for $275 with the same expiration as the put. If the price of NRQ stock rises above $40, the call will likely be exercised and you will receive $4,000 in compensation for the shares you must sell. Since the initial investment you made to purchase the stock cost you $2,000, you've made a $2,000 profit by using a collar.
Also, note that since you received $275 when you sold the call, your net cost for the collar strategy was only $25, less than one tenth of the cost of the put alone.
In most cases, collars work best in neutral to bullish markets for a stock that has performed well in the past. Just like any other options strategy, collars require attention to detail and time and are not appropriate for all investors.
In the graph shown here, the vertical (Y-axis) represents profit and loss, while the horizontal (X-axis) shows the price of the underlying stock. The blue line shows your potential profit or loss given the price of the underlying.
Examples exclude transaction costs and tax considerations.
Options involve risk and are not suitable for all investors. Detailed information on our policies and the risks associated with options can be found in Scottrade's Options Application and Agreement, Brokerage Account Agreement, and Characteristics and Risks of Standardized Options (available at your local Scottrade branch office or from the Options Clearing Corporation at 1-888-OPTIONS or by visiting www.888options.com). All option accounts require prior approval by Scottrade. Market volatility, volume, and system availability may impact account access and trade execution. Supporting documentation for any claims will be supplied upon request.