Equity Collar – The Option Strategy Desk Reference

Equity Collar

Strategy: Sell n ATM or Slightly OTM Puts, 56 DTE

Buy n ATM Puts, Same Expiry

Buy or Own n × 100 Shares

Example:

Price Chart: Downtrending off of resistance

Current IV%: 20%

IV Rank: 30

Trade: Buy one ATM put option for each 100 shares of owned stock; sell an equivalent number of slightly OTM call options to offset the cost of the long put options.

Typical Strike Deltas:

Long Puts 0.50 to 0.45

Short Calls 0.50 to 0.45

Goals: The long put options serve as a hedge against a drop in the price of the stock by moving deeper ITM. The long call is sold to offset the cost of the long put. The owned stock covers the short call options in case of a price rally.

Manage: If the long put moves deeper ITM from a drop in the price of the underlying security, a portion of the stock’s reduction in value is offset by the drop in the value of the short calls. If the stock price continues to drop and the contracts are close to expiration, the long put options can be exercised to recover from the drop in the price of the stock. This transaction would normally be auto-exercised at option expiration. When exercised, the stock is delivered to a short put seller who must pay $32 per share, that is, the strike of the long put. In addition, the premium of the short call will have dropped in value. This permits the trader to buy to close the short call options for less than originally received. Or, more likely and when close to option expiration, the short calls may simply expire worthless, which permits the trader to retain all of the premium received when the short calls were initially sold.
If the stock rallies in opposition to the trader’s bearish bias, the long put is sold for what premium remains. The short call would be bought and the trader would either keep the stock or sell it when a suitable profit is available.

Profit: Hedging strategies are used to limit losses rather than for profit. However, if the hedged stock experiences a strong price rally, the stock’s profit could partially offset the difference in option premium initially paid when the long put and short call were bought.

Loss: This trade is subject to a loss if retained during a strong rally in the price of the underlying stock.