Collars Offer Flexible Protection

Focus: OPTIONS

Gary Delany Image Gary Delany Director of European Marketing and Education, Options Industry Council

ADVERTORIAL - By using strategies like the “collar,” investors have a solution for market risk that can provide best of both worlds - protection at a reduced cost. Here, Gary Delaney, Director at The Options Industry Council, provides you with strategies for trading options that will help protect your portfolio against market risk.

Investors want the best of both worlds. They want upside participation in the market but don't want to lose their shirt if things go sour. They want protection but don't want to pay too much for it. Anyone involved in investment decisions is used to addressing these conflicting tensions. The world of equity options is no exception. The use of options as a protective risk management tool is well established but cost can often be a stumbling block.

One way of reducing the total cost of option protection is to implement the “collar” strategy. The collar is a two-part strategy: buy a put below the market (i.e. out of the money) and at the same time sell a call above the market (again, out of the money) – traditionally with both options sharing the same expiration date. The call sold offsets the cost of the put bought. By adjusting the distance that the strike price is away from the current market price we can make the combined option position more or less protective and more or less expensive. The positioning of the option strike prices relative to the underlying investment is crucial. Too far away from the underlying and the protection and cost offset are too small. Too near and the call sold may be exercised, disrupting the strategy.

A study sponsored by the Options Industry Council (OIC) written by Edward Szado and Thomas Schneeweis from the Isenberg School of Management at the University of Massachusetts analyzed a variation of the traditional collar strategy by using different expiration dates for the options.