Collar

Psychology:

A collar strategy involves buying an underlying asset and an out-of-the-money put option contract, and selling an out-of-the-money call option contract. The collar strategy is appropriate when an investor currently holds an underlying asset and desires any of the following:

• Maximize their profits by selling call option contracts
• Limiting the risks in case the underlying asset’s price declines by buying put option contracts

The reasoning behind buying an out-of-the-money put option contract for a collar is to provide some level of security since unlimited losses can occur if the underlying asset’s share price declines. Think of a covered call with the downside protection of a put.

Risk / Reward:

Maximum Loss: Limited to the total premium paid or obtained minus the loss received on the underlying asset’s leg subtracted from the exercise price of the two option contracts.

Maximum Gain: Limited to the total premium that is paid or obtained plus the profit on the underlying asset’s leg subtracted from the exercise price of the two option contracts.