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Collar

AKA Risk Reversal; Fence

NOTE: This graph indicates profit and loss at expiration, respective to the stock value when you sold the call and bought the put.

The Setup

  • You own the stock
  • Buy a put, strike price A
  • Sell a call, strike price B
  • Generally, the stock price will be between strikes A and B

NOTE: Both options have the same expiration month.

Who Should Run It

Rookies and higher

When to Run It

You’re bullish but nervous.

The Sweet Spot

You want the stock price to be above strike B at expiration and have the stock called away.



About the Security

Options are contracts which control underlying assets, oftentimes stock. It is possible to buy (own or long) or sell (“write” or short) an option to initiate a position. Options are traded through a broker, like TradeKing, who charges a commission when buying or selling option contracts.

Options: The Basics is a great place to start when learning about options. Before trading options carefully consider your objectives, the risks, transaction costs and fees.

The Strategy

Buying the put gives you the right to sell the stock at strike price A. Because you’ve also sold the call, you’ll be obligated to sell the stock at strike price B if the option is assigned.

You can think of a collar as simultaneously running a protective put and a covered call. Some investors think this is a sexy trade because the covered call helps to pay for the protective put. So you’ve limited the downside on the stock for less than it would cost to buy a put alone, but there’s a tradeoff.

The call you sell caps the upside. If the stock has exceeded strike B by expiration, it will most likely be called away. So you must be willing to sell it at that price.

Maximum Potential Profit

From the point the collar is established, potential profit is limited to strike B minus current stock price minus the net debit paid, or plus net credit received.

Maximum Potential Loss

From the point the collar is established, risk is limited to the current stock price minus strike A plus the net debit paid, or minus the net credit received.

Break-even at Expiration

From the point the collar is established, there are two break-even points:

  • If established for a net credit, the break-even is current stock price minus net credit received.
  • If established for a net debit, the break-even is current stock price plus the net debit paid.

TradeKing Margin Requirements

Because you own the stock, the call you sold is considered “covered.” So no additional margin is required after the trade is established.

As Time Goes By

For this strategy, the net effect of time decay is somewhat neutral. It will erode the value of the option you bought (bad) but it will also erode the value of the option you sold (good).

Implied Volatility

After the strategy is established, the net effect of an increase in implied volatility is somewhat neutral. The option you sold will increase in value (bad), but it will also increase the value of the option you bought (good).

Options Guy's Tips

  • Many investors will run a collar when they’ve seen a nice run-up on the stock price, and they want to protect their unrealized profits against a downturn.
  • Some investors will try to sell the call with enough premium to pay for the put entirely. If established for net-zero cost, it is often referred to as a “zero-cost collar.” It may even be established for a net credit, if the call with strike price B is worth more than the put with strike price A.
  • Some investors will establish this strategy in a single trade. For every 100 shares they buy, they’ll sell one out-of-the-money call contract and buy one out-of-the-money put contract. This limits your downside risk instantly, but of course, it also limits your upside.


Tools

422 Probability Calculator Image small
Probability Calculator Our Probability Calculator can help you estimate your probability of success for any options strategy. Just pick your underlying security and select up to two target prices. You can adjust variables...

620 Profit + Loss Calc Image small
Profit + Loss Calculator Get a thorough and visual understanding of your option trade’s profit and loss potential - before you place it.

1291 Bond Finder
Bond Finder Your one-click access to current yields on bonds over various timeframes.

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