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It can be debated whether trendy fashion retailer Lululemon (LULU ) deserved the 20% pop following its December 12, 2010 earnings report. Sure, it has continued to penetrate the yoga-mat and cupcake culture one gold-coast block at a time, but valuation remains an issue. On the other hand, why should the relatively more staid, and certainly more international Nike (NKE ) get whacked after it reported 10 days later on December 22, thudding 7% down after it gave tepid forward guidance.

I offer these two names not as judgment on their respective businesses but as examples of how earnings reports can be fickle arbiters of short-term price determination. As we head into earnings season, it is a good time to consider how using an option strategy such as a collar can carry you through large, short-term price swings.

Names such as Apple (AAPL ), Netflix (NFLX, and Priceline.com (PCLN ) must delight those who won them, but also bring fear that a poorly received earnings report in the coming month will place them in a Coinstar (CSTR ) junk heap.

Collar Can Avoid Event Risk

Next week we get a full slate of fully loaded and widely watched earnings reports leading off with none than Apple. Can this company, whose shares have gained some 68% during the past 52 weeks, put up big enough numbers next Tuesday to provide a sufficient pop to justify white-knuckling through the earnings report? Any disappointment could cause a 10-15% swoon over the next few days.

This is a perfect case in which placing a collar around an attractive position will help one wear it well during times of uncertainty. A collar is a part position; it involves owning or being long stock, shorting an out-of-the money call option, and simultaneously buying out-of-the-money put options. The two options typically have different strike spices but the same expiration period.

I’m going to look just beyond next week’s earnings report and use a February expiration to establish a collar. With shares trading at $347, one can:

• sell the February $355 call at $8.80 a contract
• buy the February $340 put at $8.50 a contract

This is a $0.30 or $300 net credit for every 100 shares by 10 contract collar. The risk is down to $340.30 prior to expiration in which the position $6.70 a share or 1.9% over the next three weeks. But what if Apple sinks $20 or some 7.6% in the coming weeks? The loss incurred with a collar in place would still be a 1.9%. Basically, any decline below the $340 strike price is limited in loss.

The upside scenario offers a similar trade-off; any price above $355 will have a limited profit of $8 share, or 2% gain during then February expiration period.

This may seem like an even up-trade, but the incremental upside combined with the piece of mind to carry though what could be a volatile period makes collars fashionable during earnings season.

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