The Collar strategy is another popular beginning options strategy. To run this strategy correctly, you’ll actually need to complete two options contracts: writing a covered call while buying a protective put.

That means that this strategy is just a combination of each of those individual strategies, with an effort to limit the disadvantages of each approach.

How It Works

There are several different scenarios that can apply to this strategy.

You can buy the put and write the call at a break even point, a net credit, or a net debit. Ideally, many investors aim for a net credit, but this isn’t available under all market conditions.

This means that there are also several possible break even points for the trade. If the option was opened at a net credit, the break even point is the initial stock value minus the credit, providing for some buffer against a potential loss.

If, on the other hand,t he trade was a net-debit, the break even point occurs at the initial stock price plus the credit amount, putting you out of the money to start.

The Advantages of the Collar Strategy

The collar strategy is most effective for investors who are interested in running a covered call strategy but are looking to minimize their risk.

Often times, it is possible to setup this strategy such that the investor has a net credit on the trade, irrespective of the stock price. If the stock price is relatively neutral and the investor continues to run the strategy for several months, they may find they reach a point where losses become impossible, as the prior income from the calls are more than enough to offset the loss of exercising the put.

Thus, this is a great strategy for income investors who are interested in minimizing risk in their portfolio.

The Disadvantages of the Collar Strategy

As with most risk-minimization techniques, the result is a costlier transaction and lower potential ROI.

The collar approach can be expensive to run, depending upon market conditions, and investors may find that the income received from writing the call is significantly reduced by the act of buying the protective put.

This means that they’ve made little profit, but limited the potential upside, since they would be forced to sell the stock in the event it rises significantly.

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