Collars | |
A collar is a strategy that consists of a long stock and a short call (a covered call), with the addition of a long put to protect against downward movement in the stock. Unlike a conversion, the put and call have different strike prices. In order for the strategy to be profitable, the premium on the call must exceed the premium on the put, and the stock price must be relatively stable. A collar has the same risk profile as a bull spread. The profit potential is limited by the short call while the risk of loss is hedged by the long put. The objective of the collar is to provide reasonable rate of return without the risk of downside loss. This strategy requires holding three positions, and the trading overhead can eat away at profits for small trade volumes. Think of a collar as a long stock with insurance, and the sale of the covered call pays for the insurance. The real cost of the insurance is the lost opportunity should the stock price rise rapidly.
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