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Michael C. Thomsett is a widely published options author. His "Getting Started in Options" (Wiley, 9th edition) has sold over 300,000 copies. He also is author of "Options Trading for the Conservative Investor" and "The Options Trading Body of Knowledge" (both FT... More
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Getting Started in Stock Investing and Trading
  • 3 Types Of Profits From Collars 0 comments
    Jan 5, 2014 12:31 PM

    A collar consists of three parts: 100 shares of long stock, one covered call, and one long put. The cost of the put is covered by income from the call. So if strikes are the same, nothing of note happens. If the stock price rises, it gets called away. If the stock price falls, you exercise or sell the put.

    Sop why even open a collar?

    There are three ways you can create consistent profits with collars:

    1. Use different strikes. If you use the same strike for both options, it is very difficult to create profits. But if both sides are out of the money, you can profit on one side or both sides of the option trade. For example, a stock was selling at $81.15 shortly after the opening. At that time, you could set up a collar using 80 puts and 82.50 calls - both were slightly out of the money. The June 80 put was at 1.06 and the June 82.50 call was at 0.56. So for a net cost of $50 (plus trading fees) you set up the collar. If the stock price rises but remains under $82.50, the call expires worthless. If it falls lower than $80, the put gains intrinsic value. Both of these outcomes are possible before expiration, but it is tough to make a lot of profit by varying the strikes.

    2. Use short-term calls and long-term puts. Another strategy involves buying longer-term puts and shorter-term calls. The theory here has two components. The out-of-the-money calls are likely to expire worthless and can be replaced several times before the put expires, creates overall profits. For example, the stock's December 80 put was at 4.45. So buying that put and selling the June 82.50 call at 0.56 still leave about $400 to offset; but there are three more expirations before that happens, so the "installment collar" makes sense as long as premium levels justify it.

    3. Incorporate the collar into a dividend timing strategy. Finally, the collar solves the problem for the risk-conscious trader who wants dividend income but does not want to risk losing money in the stock. The company's dividend was at 3.01%. This is a decent return, but there is always the threat of losing money in the stock. The collar solves this. If you set up the collar before ex-date (for example, in Feb, May, Aug and Nov), you get the dividend, but the collar eliminates market risk for very little cost. In fact, exercise is desirable after ex-date because you still get the dividend. This frees up capital to repeat the strategy the following money in a stock with ex-dates in Mar, June, Sep, and Dec. - and then again in Apr, Jul, Oct, and Jan. Moving in and out of stock to hold the position for a few days just to earn dividends gets you a much higher return than the annual, because you get dividends every month instead of quarterly. And the collar eliminates the market risk.

    To gain more perspective on insights to trading observations and specific strategies, I hope you will join me at ThomsettOptions.com where I publish many additional articles. I also enter a regular series of daily trades and updates. For new trades, I usually include a stock chart marked up with reversal and confirmation, and provide detailed explanations of my rationale. Link to the site at ThomsettOptions.com to learn more. You can take part in discussions among members on the site at the Members Forum.

    I also offer a twice-monthly newsletter subscription if you are interested in a periodic update of news and information and a summary of performance in the virtual portfolio that I manage. Join at Newsletter - I look forward to having you as a subscriber.

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