The power of the Long Stock Collar Strategy
A long stock collar option strategy, also known simply as a “stock collar,” is an options trading strategy that involves holding a long position in a stock while simultaneously using options to limit both potential losses and gains. It is essentially a combination of three components: owning the underlying stock, buying protective puts, and selling covered calls.
Just like how the protective collar on a weight bar keeps the weights from falling off in a sudden shift in balance, the Long Stock Collar protects your stock in case of a sudden shift in price.
How the long stock collar strategy works:
There are three components to a Long Stock Collar- the stock holding, a Protective Put, and a Covered Call.
Long Stock Position: The strategy starts with you holding a long position in a specific stock.
Protective Puts: To protect against potential downside risk, you purchase an out-of-the-money put option. These put options give you the right, but not the obligation, to sell the underlying stock at a predetermined price (strike price) within a specified period (until the option’s expiration date).
Covered Calls: To generate income and offset the cost of buying the protective puts, you sell an out-of-the-money call option. By doing this, you obligate yourself to sell the underlying stock at a predetermined price (strike price) if the stock’s price rises above that level before the call option’s expiration date.
When to use a long stock collar strategy
This strategy is suitable when you hold a long position in a stock but you want to protect yourself against potential losses in case the stock price declines. It gives you a protective position.
Buying protective puts comes at a cost in the form of the option premium. If the stock price does not drop significantly or remains above the put option’s strike price, the cost of the put option is essentially a loss. But with the Covered Call portion of this strategy, your Put premium is covered.
This strategy is best used when you believe that the stock’s price will not experience significant gains in the near term. The reason is that this strategy will cap your potential gains if the stock rises significantly.
Use it for Income Generation
If you believe the stock is trading near its peak and is unlikely to rise much more, the covered call portion of the strategy provides a way to generate income through the premiums received from selling the option. Calls typically carry a higher premium than puts, so even with buying the Put, you may be able to receive a net credit when you open the position.
It’s a great way to earn extra returns when a stock isn’t rising. But with the protective put, you’re still covered if the stock falls.
When not to use a Long Stock Collar
This strategy puts a cap on potential gains when a stock is in an uptrend. With the Covered call, you’re obligated to sell the stock at the predetermined strike price if the stock prices rises significantly. If the stock price exceeds this level, you will end up selling the stock, and no additional gains will be realized.
If a stock is generally in an upward movement, there are other strategies that might be better suited for you. Instead of a Long Stock Collar, maybe consider doing Bull Spreads instead.
Before employing any options strategy, it’s crucial to thoroughly understand its mechanics and potential risks. You should carefully assess your risk tolerance, market outlook, and investment goals before implementing a long stock collar strategy or any other options strategy.
Have you used this strategy before? Let me know in the comments.