The collar trade is designed to be a long-term trade, usually more than 12 months expiration.
Long-term calls have more time value compared to long-term puts. The more distant the expiration date, the larger is this different.
Here’s an example of a collar spread:
- Buy 100 shares of ZZZ at $19 per shared.
- Buy 1 Jan 2021 20 Put @ $2.90
- Sell 1 Jan 2021 25 Call @ $1
The net cost is (2.90 – 1.000) x 100 + 190 x 100 = $2090.
If the stock price falls below $20, the stock will be called away at $20. The call will expire worthless.
If the stock price goes above $25, the stock will be called away at $25. The put will expire worthless.
The maximum potential loss on a collar trade can be reduced by moving the strike prices closer together, but this also reduces the maximum potential proceed. The strike price of the short call must always exceed that of the long put in order for a profit to be possible.
To achieve the maximum return, it is generally required to stay in the trade until expiration.
Standard collar trades on highly volatile stocks are generally not appealing. Collar trades are for more conservative stocks.
The higher volatility usually results in a greater net cost fot the options. This will increase the maximum possible loss on the trade.
Advanced collar trade
The standard collar trade can be modified to give better payoffs.
Use a call option instead of holding the stock
Since an in-the-money call option price with a high delta moves almost together with the stock price, consider buying the call instead of owning the stock.
Sell fewer calls for unlimited profit potenail
If 400 shares are bought, consider selling 3 calls on the collar trade. This will will free up 100 shares for unlimited upside profit.
Sell another further out-of-the-money put for extra money
For example, sell another 1 out-of-the-money 17.50 Put for extra money. In case the stock price starts falling, the puts will cancel out each other. It may be necessary to put on a stop loss order on the stock.