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Collar Spreads...
The Collar Spread is similar to the Covered Call trade, except an investor will purchase an OTM put to protect against a sudden decline on the stock. Like the Covered Call, the Collar Spread is a nuetral to bullish strategy. In a Collar Spread, an investor will buy shares of stock and then sell an ATM or OTM call against those shares, just like a Covered Call trade. Then, the investor will purchase an OTM put. The primary risk in a covered call strategy is that the underlying stock may decline faster than we can collect premium. By purchasing an OTM put option we can protect the position from a large drastic decline in the stock price. The covered call sale helps finance the purchase of the put option.
Since the loss in the stock price is limited by the put, a maximum loss can be calculated.
The net credit and maximum risk are presented in the SmartSearchXL results.
Collar Spread TradingExample: Buy stock XYZ at $44.92 per share.
Collar Spread TradingWrite (Sell) the OCT 45 Call at $4.00
Collar Spreads Advice - Collar Option SpreadsBuy the OCT 35 Put at $0.85 (for downside protection)
Net Credit = Call Bid Premium - Put Asked Premium = $3.15
% if Not Assigned = Net Credit ÷ Stock Price = 7.0%
% If Assigned = (Net Credit + Stock Profit/Loss) ÷ (Stock Price - Net Credit) = 7.7%
Max. Risk = Stock Price - Put Strike - Net Credit = $6.77
% Max. Risk = Max Risk ÷ (Stock Price - Net Credit) = 16.2%
Max. Profit = Net Credit + Stock Profit/Loss = 3.15 + 0.08 = $3.23
Break Even = Purch. Price of Stock - Net Credit = $41.77

Collar Spreads Advice - Collar Option Spreads
As a comparison, let us look at the risk-reward ratios of trading the 45 Call but purchasing the 40 Put on the same stock:
Collar Spread TradingExample: Buy stock XYZ at $44.92 per share.
Collar Spread TradingWrite (Sell) the OCT 45 Call at $4.00
Collar Spreads Advice - Collar Option SpreadsBuy the OCT 40 Put at $2.00 (for downside protection)
Net Credit = Call Bid Premium - Put Asked Premium = $2.00
% if Not Assigned = Net Credit ÷ Stock Price = 4.5%
% If Assigned = (Net Credit + Stock Profit/Loss) ÷ (Stock Price - Net Credit) = 4.9%
Max. Risk = Stock Price - Put Strike - Net Credit = $2.92
% Max. Risk = Max Risk ÷ (Stock Price - Net Credit) = 6.8%
Max. Profit = Net Credit + Stock Profit/Loss = 2.00 + 0.08 = $2.08
Break Even = Purch. Price of Stock - Net Credit = $42.92

Collar Spreads Advice - Collar Option Spreads

The first spread (Sell the 45 Call, Buy the 35 Put) would yield a higher return if Assigned and a higher return if Not Assigned. This is because the deep OTM Put has a low premium and the premium from selling the call is not reduced that much. The first spread also offers a higher Maximum Profit for the same reason.
The second spread (Sell the 45 Call, Buy the 40 Put) offers a much lower Maximum Risk, thus a much lower % Max. Risk. This is because the Protective Put strike is much closer to the price of the stock. An investor would not collect as much credit on the spread, but they would have a better protection in the case of a stock correction.
The PowerOptions database matches up every call that is written with a protective put option. The "% If Assigned" and "Downside Protection" returns that are then calculated take into consideration the cost of buying the protective put option. Most investors will trade a Collar Spread that results in a net credit, where the premium (bid) for the short call is greater than the ask price of the put. However, debit Collars are also available on PowerOptions. The SmartSearchXL tool will allow you to find either of these types of spreads above. A PowerOptions Subscriber can also utilize the OneStrike tool to compare the different risk-reward ratios of different Collar trade combinations on a given stock. Although we offer patented tools to find and compare the different combinations available, it is up to the individual investor to determine their own risk-reward tolerances and decide which Collar trade best fits their investing strategy.

Collar Spreads Advice - Collar Option Spreads - Collar Spread Trading


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