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The wide collar, or as it’s sometimes called, the “loose collar,” is a strategy suited to specific traders operating under a specific set of circumstances.
The strategy permits both bigger losses and gains than a traditional collar, but the likelihood of either the underlying shares being called away or the put protection being activated is also more remote. For this reason, the strategy is best employed under the following circumstances:
- The trader owns the underlying and is in a healthy profit position;
- He has a bullish bias; and
- The underlying is expected to trade in a range for the near term.
The component parts of the wide collar are the same as a traditional collar: ownership of 100 shares of the underlying, one short call and one long put. The only difference is that the strike prices of the options are “widened” to sit out of the money and offset one another in price.
Have a look now at a case study using Boeing (NYSE: BA) stock to better appreciate the specs of the strategy.
With Boeing shares locked in a range for many months – and little notion of when a breakout might occur – you decide to put on a long-term, wide collar. This variation will allow you to profit to a greater degree than a regular collar, even though it opens you up to a potentially greater downside.
By early May, your patience is tested and you decide to make the trade. With the shares trading at exactly $74, you buy the March 69 put for $4 and offset the cost by selling the March 79 call for the same price (red circle). You end up with a zero-cost collar with both strikes well out of the money (black squares).
Rationale: A Bullish Bent
You normally wouldn’t set the strikes so wide. After all, your protection only arrives at $69, leaving you open to a $500 loss should the shares take a nosedive.
That said, you bought the stock in the mid-$30s, so your profit is already substantial. Moreover, you believe the stock could spike higher before expiry, and you’re loathe to relinquish those potential gains by setting the call strike any lower. You also want to establish the trade at zero cost.
All told, the wide collar is the best means of securing the type of protection you desire while still leaving a reasonable potential profit in place.
As it turns out, the stock drifts between the two strikes for another nine months before breaking higher. By expiry in March, the stock is changing hands for $86.50.
Your shares are called away at $79, offering you another $500 ([$79 – $74] x 100), the maximum gain on the trade. You’re satisfied.
Maximum loss, had it occurred, would have been triggered at or below the long put strike at $69, resulting in a hit of $500 ([$74 – $69] x 100).
Trading note: The wide collar strategy can also be employed on a short sale by reversing the above and buying an out-of-the-money call while selling an out-of-the-money put.
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