Taking our options trades one step further, another one of the options strategies I use quite often is the Collar. With a Collar a Call is sold against shares that are owned (or purchased at the time of the trade) and, with the premium dollars taken in from sale of the Call, a lower strike Put is purchased for the same shares. For example:
100 Shares of XYZ company are purchased for $25.00 per share on January 1st.
At the same time a February $26.00 Call is sold against the shares for $0.50, or a $50.00 premium (100 x 0.50 = 50.00)
Along with the sale of the Call, a February $24.00 Put is purchased for a price of $0.40, or a debit of $40.00 (100 x 0.40 = 40.00)
Excluding broker commissions and fees [private] (which can be a BIG exclusion), the trader will, essentially, make $10.00 on the trade if the stock’s price remains within the $24.00 to $26.00 range — think of it a a $10.00 dividend payment. (That $10.00 dividend, however, will be affected by broker commissions and fees, which is why it is so important to try and keep them at a minimum.)
If XYZ’s stock is above $26.00 per share by expiration (i.e. the third Friday in February), then the trader will make $110.00 (26.00 – 25.00 x 100 + 10.00 = 110.00), less broker commissions and fees. With the Put in place, the most the trader can lose is $90.00 (24.00 – 25.00 x 100 + 10.00 = 90.00), less commissions and fees.
The one caveat to this strategy, however, is that it works best with stocks that have an abundance of options available for trade. For some companies the number of available options is small; in yet others, options may be nonexistent. For many large cap companies, however, there are plenty of options available for this type of trade or investment strategy. (Also worthy of mention is the fact that the example above does not take into consideration any dividend payments that may be awarded during the time the stock is owned.)
Generally, if I feel a company is fairly valued I will employ this strategy (as opposed to using Naked Puts) — especially when trading dividend paying companies that have a dividend payment coming due. It offers me the opportunity to capture a dividend payment while adding to the dividend with the premium dollars I collect from selling a Covered Call. With the Put in place, I can also rest more easily knowing that any losses that may occur from large downside moves will be capped. AND, if the shares are not called away, I can attempt to make a similar trade once the options expire.
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