Unique Twist on Options Collar

A powerful option strategy you may want to add to your existing portfolio is a put spread collar. It involves selling a covered call and buying a put spread on a stock that you already own. The strategy offers a loss cushion in exchange for capping the upside.  And it's probably one of the best kept secrets among the pros.

Here’s an example of a put spread collar in action. For instance, suppose you own 100 shares of $TSLA trading at $100 per share. You might be able to sell a call at $120 strike, buy a put at $100 strike, and sell a put at $80 strike (all expiring in a year) for a net cost of zero upfront. The result of this strategy is you would have a 20% loss cushion and a 20% upside ceiling. $TSLA would have to fall below $80 for you to start losing, and in exchange for that protection you limit your potential upside to $TSLA reaching $120. Your maximum loss with this strategy would be $8,000 versus the $10,000 exposure you would have originally had just owning the shares.

How do I profit with this strategy? The returns for this type of strategy are variable and follow the movement of the market prices. As an investor, you would avoid any losses with this trade as long as the price of the underlying asset stays above your cushion. Someone who is simply long shares of $TSLA for example would immediately start losing as the price drops, but with the protection of this put spread collar in play, you would not participate in that loss until the price goes below your cushion at maturity. On the other side, as $TSLA price moves up, you see returns that match the $TSLA rally up to your ceiling. Beyond that point you are exposed to the risk of missing out on additional profits if the price continues to move up beyond your ceiling. 

‍What if I don’t own 100 shares of stock? You can also initiate a new position by buying shares and executing the option legs outlined above. Alternatively, those who wish to use margin could just sell the $80 put and buy a call spread. 

On non special margin underliers, brokers may allow you to hold much less capital in a margin account. For example, Charles Schwab typically requires an initial maintenance margin of 30%. But for certain volatile stocks, the initial maintenance margin is higher. These are considered special margin underliers. A couple well known examples might be stocks like AMC Entertainment ($AMC) which has a special maintenance margin of 100% on long positions and 200% on short positions or Gamestop ($GME) which also require 100% on long positions, and 300% on short positions as of mid 2022. ‍

Know your risks. For the typical marginable equities you could sell an $80 put requiring less than $2,400 of initial margin as opposed to $8,000. This options only strategy can be more capital efficient but also may increase the downside risk. Be sure to study the risks associated with options and margin accounts. 

‍When would you use this strategy? A put spread collar is ideal for capital preservation with some potential for growth. It gives you higher upside potential than a traditional options collar strategy, while exposing you to more downside risk which makes it more aggressive than a traditional collar. Bottom line, however, this is a conservative strategy compared to the completely unhedged position of being long shares of an asset.

Consider this and many other protective option strategies available to enhance your portfolio. Join Olive to start investing smarter.