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Collars

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Collars are a strategic combination of covered calls and protective puts which control risk. Collars give you financial protection. The costs of collars are reduced, since the premium of one option purchased is offset by another option written. The options are created with the same expiration date.

Traditional collars protect you if you already own the underlying asset. It is typically used after acquiring substantial unrealized gains. You purchase out the money put options, and write out the money call options. The actual payments made and payments received should cancel each other out, so the cost of taking the position should total zero. Your written and held options should expire on the same date. Collars are used to protect gains beyond one level and control risks beyond another level. The purchased out the money put protects you from price falls. You can exercise the put to sell underlying assets for more than their worth if the market price falls below the strike price. The written call fuels the put options, and that call will be exercised if the market price exceeds the strike price. Massive gains will be exercised and you won’t keep the profit.

A reverse collar functions similarly. This strategy begins with you owning a short sale on the underlying asset. You will sell out the money puts and use their premiums to buy out the money calls. The expiration date will be the same. The call protects the short sale. If the market price rises above the call’s strike price, you will exercise the call to purchase the asset at the strike price. The strike price will be below the market price, which spares you some losses when closing your short sale. If the underlying asset’s market price falls below the put’s strike price, the put holder will exercise the option. You will be forced to purchase the underlying assets which are needed to close your short. When you deliver these securities to the underlying asset lender, you secure your short sale profit.

Traditional collars protect you if you already own the underlying asset. It is typically used after acquiring substantial unrealized gains. You purchase out the money put options, and write out the money call options. The actual payments made and payments received should cancel each other out, so the cost of taking the position should total zero. Your written and held options should expire on the same date. Collars are used to protect gains beyond one level and control risks beyond another level. The purchased out the money put protects you from price falls. You can exercise the put to sell underlying assets for more than their worth if the market price falls below the strike price. The written call fuels the put options, and that call will be exercised if the market price exceeds the strike price. Massive gains will be exercised and you won’t keep the profit.

A reverse collar functions similarly. This strategy begins with you owning a short sale on the underlying asset. You will sell out the money puts and use their premiums to buy out the money calls. The expiration date will be the same. The call protects the short sale. If the market price rises above the call’s strike price, you will exercise the call to purchase the asset at the strike price. The strike price will be below the market price, which spares you some losses when closing your short sale. If the underlying asset’s market price falls below the put’s strike price, the put holder will exercise the option. You will be forced to purchase the underlying assets which are needed to close your short. When you deliver these securities to the underlying asset lender, you secure your short sale profit.

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