Stocks & Commodities V. 27:5 (62): Explore Your Options by Tom Gentile

Explore Your Options by Tom Gentile

COLLAR CONFUSION

I read some messages from other traders about collars and I’m confused. My understanding is these were a bearish strategy, but above all they’re for insurance on your stock. What I don’t understand is many forum contributors advise that collars are a bullish strategy! Sure, I want my stock to go up ... but if I’ve already got stock, then taking out a collar seems impossible to make money in a bullish market (over and above a gain in stock price). If my puts keep expiring worthless, and I have to keep buying my calls back at a higher price and then selling the next month, it’s going to cost me a fortune! All my profit from the rising stock is being eaten up by rolling up my calls!

Your understanding of collars is correct. The trade is created by selling calls and buying puts. Without any stock, the strategy is bearish because both short calls and long puts have negative deltas. Therefore, they will decrease in value as the stock moves higher and increase in value as the stock price moves lower. Since the collar consists of long shares and puts along with short calls, it can also be viewed as a protective put (shares protected with puts) along with short calls. Or it can be considered a combination of a protective put and a covered call (buying stock and selling calls). The calls help pay for the puts, but also limits the upside.