Option Strategies Details
Own 100 shares then sell an OTM Call and buy and OTM Put
1. Limit (drastically) your stock's upside profit to protect against large price decreases
Up
Down a lot
Stock price remains anywhere between the Call and Put strikes
None since a breach of the sold Call simply results in your shares being called away
Stock price minus the strike price of the long Put
Collar
You own (long) 100 shares of stock then sell (short) an OTM Call and buy (long) an OTM Put
Description
A trader who forecasts a large price decrease and increasing volatility on a stock position that cannot be immediately sold can be protected by a Collar. The trader may pay a small debit, receive a small credit, or even open the position for exactly $0.
Suppose stock XYZ is trading at $373 and you own 100 shares. You forecast a large decrease in XYZ price and an increase in volatility, but you want to collect a large dividend that is associated with XYZ in the near future.
You open a $380 / $365 Collar (selling the $380 Call and buying the $365 Put) for $0. How is this possible? The $380 Call bid price is $5.35 and the $365 Put ask price is $5.35, so when you sell the Call you receive a $5.35 credit, and you then use $5.35 credit to buy the $365 Put.
Your max loss on the position is $8 per share, or $800, since stock XYZ below $365 is protected by the long $365 Put and the current price is $373: $373 - $365 = $8 (per share). The max profit on the position is $7 per share, or $700, since stock XYZ above $380 will be called away by the short $380 Call and the current price is $373: $380 - $373 = $7 (per share). There is no "free lunch" here since you had to sacrifice any profit above $7 per share in order to protect yourself from a decline larger than $8. Because of the nature of this structure, the term "breakeven" can be a bit confusing, but since Collars are usually executed for $0 the "breakeven" of the options is anywhere between the strike prices of the Call and Put.