Collars

A collar allows an investor to help hedge a long (short) underlying security position by buying (selling) a put with a strike price beneath the current stock price and selling (buying) a call with a strike above it. Both options have the same expiration date. The user accepts a cap on his upside (downside) gains for a floor on his downside (upside) losses.

For use when investor anticipates:

• Volatile market conditions
• Any missed opportunities are perceived to be worth the risk mitigation

Financial Characteristics:

• Maximum Loss vs. Long Stock: Current Stock Price - Strike Price of Put +/- Net Premiums
• Maximum Loss vs. Short Stock: Strike Price of Call +/- Net Cost of Collar - Current Stock Price
• Maximum Gain vs. Long Stock: Strike Price of Call - Current Stock Price +/- Net Premiums
• Maximum Gain vs Short Stock: Current Stock Price - Strike Price of Put +/- Net Premiums

Objectives:

• Hedge an existing position for the short term that customer is willing to sell (buy in) at a set price.
• Risk mitigation in exchange for limited profit potential
• Lower cost protection than purchase of protective put alone

EXAMPLE - Collar on long equity position

An investor is long 100 shares of XYZ at $64.00, and wants to protect his downside risk using a protective collar. The important things are the percentage loss the customer is willing to assume, and the point that the investor is willing to lose the stock through assignment of the short call position. Let's assume that the investor is only willing to lose 5 to 10 percent on the downside, and will only sell his stock on a 10 to 20 percent move upwards. Let’s assume that the XYZ 60 Puts are trading at .95, and the XYZ 75 Calls are trading at .95. The net effect of establishing a collar (long stock +long put + short call) using these two strikes is a net debit/credit of $0. The investor is protected after a 6.25% loss, and may participate in an upside move of up to 17.2%. The investor assumes some risk of loss in exchange for retaining some of the upside potential of his XYZ position. With a net debit/credit of $0, the breakeven price for this strategy remains $64.

Commissions, taxes, and transaction costs are not included in any of these strategy discussions, but can affect final outcome and should be considered. Please contact a tax advisor to discuss the tax implications of these strategies. Many of the strategies described herein require the use of a margin account. With long options, investors may lose 100% of funds invested. In-the-money long puts need to be closed out prior to expiration, since exercising them could create short stock positions.

Options carry a high level of risk and are not suitable for all investors. Certain requirements must be met to trade options through Schwab. Multiple leg options strategies will involve multiple commissions. Please read the options disclosure document titled "Characteristics and Risks of Standardized Options." Member SIPC