What is Collar Option Strategy for Beginner?
A collar option strategy is one of the popular option trading strategy. Typically, it used to limit both trades (gains and losses). Traders can create collar option and implement it as a strategy by holding the underlying stock they are trading. It allows the trader to buy an out of the money put option, as well as selling that stock out of the money call option under the same trade. Let’s see how the collar option strategy for beginners work in this trading industry.
It’s a good idea to have strategies to protect yourself from the turmoil in financial markets in turbulent times. We bring you a protective Collar Option Strategy that protects against loss, but it costs a bit like all insurance. Today we are dealing with the collar options strategy, a combination of covered call and protective put strategies.
What is Collar Option Strategy?
It is a strategy that is a variant of the Covered Launch, which has a more conservative profile. Simultaneously, it can ensure profits regardless of the value of the underlying in some instances.
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Let’s not overlook the latter: guaranteed profit regardless of the value of the underlying.
The collar option strategy is a Covered Throw to which the purchase of a Protective Put is added. Seen from another angle, it is a Protective Put to which we launch a call.
The operations involve the following 3 things:
- Buying a Share/Stock
- Launch a Call
- Buying a Put
How Does a Collar Option Strategy for Beginners Work?
The collar strategy works very much like the protective put strategy. It means that it prevents the share price from falling below the put price. The difference is adding a short call option (selling a call option), which on the one hand, limits the maximum profit.
But on the other hand, it covers some or all of the costs of the put option.
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The investor selects the call’s exercise prices and puts options depending on the scope of protection expected. It is often the case that strike prices are evenly distributed below and above the current share price. So, it causes the investor to allow both some loss and some gain.
The objective is the same as the Protective Put but at a lower cost. This objective could, as we already mentioned, reach zero loss or even guaranteed profit. But it depends on
- The Market Context
- The Underlying on Which We Operate, and
- The Premiums We Manage to Negotiate
Pros & Cons of Collar Option Strategy for Beginners
Well, before moving on to real trading, it is necessary to understand collar option strategy for beginners. To make it easier for you, we have shared the pros and cons to understand the benefits and difficulties of this particular trading strategy. Suppose we acquire and hold 100 Apple shares in June 2020 with a long-term perspective. We buy shares for $ 149 apiece.
Pros of Collar Option Strategy
To increase the yield from holding these securities, we can issue CALL options with an exercise price of $ 155. And we can put the expiry date of, for example, November 2020.
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The only thing it will oblige us to do is, if necessary, resell all shares in November. Of course, the price will be $ 155. It shouldn’t worry us too much, because we bought them for $ 149.
In return for this commitment, we would immediately get a total of $ 395 in bonuses to our account. This money is credited to the account when the options are issued and can be used freely.
It’s worth noting that $ 395 is 2.65% of $ 14,900 (100 shares x $ 149). With this one procedure, we increased the profit on the entire investment by 2.65%. No matter what happens to the Apple rate. Isn’t it that simple?
Cons of Collars Option Strategy
So the “worst” thing that could happen in this case is if the rate rises. Suppose it increases well above $ 155 and hits a level, say, $ 160 in November.
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Then, regardless of everything, we will be forced to sell our shares for $ 155. This means that we will actually earn less than we would have earned on the price increase without writing options.
However, if the share price does not exceed the $ 155 barrier, the options will expire worthlessly. We keep $ 395 in our pocket, and we can immediately issue new options with an expiry date. For example, for December, for which we will again collect several hundred dollars of pure profit.
How Does It Look in Practice?
Suppose we took a Covered CALL position on Apple in June. We bought 100 shares for $ 149. And we issued one CALL option with an exercise level of $ 155, for which we received $ 395.
Let us now analyze the four variants of the development of events that are possible in November. November is the expiry date.
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Option 1: The Rate Rises to $ 160
The price has exceeded the option exercise level. So we must meet our obligation to sell our shares at $ 155. We do that too.
So, having previously bought 100 shares for $ 149 and now selling them for $ 155, we made $ 600 plus $ 395 from writing options, which is $ 995 in total.
Suppose we hadn’t written options and had bought shares for $ 149 and then sold them for $ 160. We would have made $ 1,100.
And this is actually the worst evil that can happen to us because it is the only case in which we will do worse than others by using the collar options strategy.
Option 2: The Rate Rises to $ 153
The rate in November only rose to $ 153, so the options expire worthlessly. All Apple stockholders made $ 400 from this growth. But we made $ 795 because the share gain is $ 395 profit from writing options.
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Option 3: The Rate is USD 149
Now finally, on the option expiry date, the share price is at the starting point. Our profit will be the price we received for writing the options that have now expired worthless. So we’re up to $ 395, while those who keep pure stocks break even here.
Option 4: the Rate Drops to $ 145
If, on the other hand, the share price fell from $ 149 to $ 145 in November, all stockholders would lose $ 400. And we would only lose $ 5 because a profit of $ 395 almost entirely covered the $ 400 loss on the share value.
So, in three out of four possible events, we will be better off than people who do not.
Covered CALL will therefore bring additional benefits when on the option expiry date:
- Share Price Will Rise Slightly
- It Exceed the Option Exercise Price by Less Than $ 3.95
- Entire Share Price Will Standstill
- The Share Price Will Fall.
Discussion on Collar Option Strategy for Beginners Ends Here
We have tried to explain everything about collar option strategy for beginners. It is suitable for investors who want a reasonable return on investment with a lower level of risk. Therefore, the biggest benefit is that it provides greater protection in case the market starts to move against the position. But if you want to enter a secure trade, why not try this one?