The Collar: is the use of a Protective Put and a Covered Call on the same asset.
If you are unsure about what either of these are, go to the previous option strategy post (post #1) and read about them because I am writing this post on Collars assuming familiarity and a decent understanding about what they are.
When to use a Collar
You’d use a collar if you want the profit structure of a covered call with the protection of the put.
Once writing the call, the premium that you receive subsidizes the purchase of the protective put. This limits your potential losses at the break even price of the put, while still allowing profits from selling your asset at a reasonable strike price.
If the call is never executed you still might be able to pull a decent profit once it expires, assuming the price at expiration is above the price that you purchased the equity.
Considering the downside protection from the put during the contract length, this is a good strategy for a conservative trader who expects a modest price gain but wants protection in-case things go south.
The profit potential of a collar is similar to that of a covered call — it is limited to the profits received from selling at the strike price of the written call.
However, in the collar you do not benefit from the additional income created by the premium of call. The premium received goes towards paying for the put protection.
By establishing a collar, you make a decision to lower your profits if things go right in order to lower your risk of loss if things go wrong.
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