How to Use a Collar Options Strategy

Options trading is full of interesting names and terms, but don't let that fool you. The right options strategy can in fact save you headaches - and make you lots of money.

Take, for instance, a collar options strategy. The options collar is a strategy to protect gains in a stock that has already had a nice move higher. It is better than selling the stock to lock in your profits, because you still get to participate if the stock moves up a little more.

And it is better than just buying a protective put, because it is usually much cheaper.

Here's how it this options trading strategy works.

Let's say you own a stock with a nice paper profit but don't want to cash it in just yet. Maybe you think it can move a bit higher. Or perhaps you know a fat dividend is coming up and you want to get it without risking your capital gains.

What you do is buy a put option with a strike price at or just below the stock's price. And at the same time, you sell a call option with a strike price at or just above the stock's price.

Basically, you "collared" the stock with an option above and below. Put another way, you bought a protective put and partially paid for it by selling a covered call. And depending on the specifics of each option, it is possible to pay for the whole put with the call. In other words, the net cost to you could be zero.

Of course, there is no free lunch. In exchange for protecting you from losses should the stock price fall, a collar will cap the amount of additional profit you can earn, should the stock price rise even further.

Many investors are sitting on gains but are worried that a major correction is just a tweet away. Why not get a little insurance to protect your winnings?

Money Morning's options trading specialist, Tom Gentile, has a simple options collar you can run right now based on a stock many investors already have in their portfolios.

Tom's Example of a Collar Options Strategy

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Let's say you bought Facebook Inc. (NASDAQ: FB) stock in January of this year, just before its price took off. Its price at that time was $150 per share. It closed Thursday at $206.06, but for argument's sake, let's round that to an even $200 per share.

In Tom's example, you have 100 shares, purchased at $150 for a total cost of $15,000. Right now, they are worth $200 per share, so you are sitting on a nice $5,000 paper profit.

But it's the holiday season, and you'd rather head up to Grandma's house for family dinner than watch your stocks. You can lock in that profit for 30 days with an options collar.

Think of this insurance policy as Tom Gentile's holiday gift to you. All you need to do is construct the following collar:

  • Sell 1 FB200117C200 - a Jan. 17, 2020 $200 call for $5.85
  • Buy 1 FB200117P200 - a Jan. 17, 2020 $200 put for $5.55

Keep in mind that options prices change constantly, so you may not get these exact prices.

But the point is that with this particular set of options, you buy insurance for the next month and actually receive a net credit in your account to do so.

Talk about a win-win!

Of course, you do give up any appreciation above $200. But you also don't have to worry about the market while you are roasting chestnuts and sipping eggnog.

The best part is that this will work with any stock with an active options market. And if your stock does not have a good options market, you can still protect yourself from a major market decline with a collar on the S&P 500 ETF (NYSEArca: SPY).

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