To Close Or Not To Close?
Introducing The “Open Collar” by Jay Kaeppel
Options can be used in many ways in an effort to hedge existing stock positions and/or to generate additional income from a stock portfolio. Options are ideally suited for both tasks and offer investors a great deal of flexibility. The purpose of this article is to help you to understand a relatively little-known hedging strategy that I refer to as the “open collar,” which combines the best parts of several other commonly used hedging strategies while also limiting some of the negatives associated with these alternatives.
STANDARD APPROACHES TO HEDGING WITH OPTIONS
The standard approaches to using options to hedge an existing stock position are:
• Selling covered calls
• Buying puts
• Applying a “collar” — this involves a combination of selling calls and buying puts.
I’ll look at these possibilities individually as a leadup to discussing the open-collar strategy. For the purpose of illustration, I will assume that an investor/trader is presently holding a position of 500 shares of Cisco Systems (CSCO). Looking at Figure 1, you can see that CSCO has enjoyed a strong advance in price over the past year. I will also assume that due to recent divergences in the moving average convergence/divergence (MACD) and relative strength index (RSI) following a strong advance, if you are holding a long position in the stock, you will be concerned that CSCO may experience a pullback in the near term. However, instead of selling your stock shares, you may want to look for a way to temporarily hedge this stock position using options.