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Twitter A put spread collar has the same structure as a traditional collar, but with one additional component: one out-of-the-money short put.
So, if an investor holds, say, 100 shares of the underlying and wants to secure it against a potentially dramatic loss, he “collars” the trade by buying an at-the-money put and finances it with the sale of an at- or near-the-money call.
The only problem with that (traditional) approach, however, is that it limits any upside gain in the shares at the strike of the short call, which is generally a marginal amount.
What to Do?
That’s where the put spread collar comes in. In order to secure a little more breathing room on the upside, an additional put is sold 10% to 20% out of the money. With the short call no longer required to carry all the weight (the short put, after all, is also happy to contribute to the credit side of the trade) the short call strike can now be “pushed” higher, offering further room for the stock to run if need be.
Before we look to a practical trading example, let’s first review the four distinct elements of the put spread collar.
- Ownership of 100 shares of the underlying.
- Purchase of one long-dated (roughly one year) at-the-money put.
- Sale of one out-of-the-money one-month call (resold every month).
- Sale of one long-dated (roughly one year) out-of-the-money put.
Below is a chart of United Parcel Service (NYSE: UPS) to help us with all the ins and outs.
You’ve owned UPS shares for a while, but by late March they’ve drifted lower to your original buy price at $100, and you have doubts as to what the future holds. You speak to your broker about putting on a collar, but he feels there may be some upside to the stock, and you, too, would hate to lose out on a rebound.
He suggests you employ a put spread collar, an option that gives you a chance to set your short call higher, and thereby profit from some additional gains.
Locking In
With the shares still sitting at $100, you act (red circle). You buy the January at-the-money 100 put for $6 and sell the January 87 put for $1.50. You then proceed to sell the April 106 call for $0.80, and continue to do so month after month, with an average premium of $0.70 garnered until the trade closes seven months later (all option strikes in black).
At the October expiry, the stock takes flight and your 105 call ends up in the money. The shares are called away, and your profit breakdown is as follows:
Shares: +$5
Short 87 put: +$1.50
Short 105 calls (over 7 months): +$4.90
Total credits: $1,140 ($11.40 x 100)
On the debit side sits the long put, which cost $6, leaving you with a net profit of $540 and two open puts – one long, one short and three months yet to run.
You could leave the puts to wither through expiry, but you prefer not to take any chances, particularly with the short.
You check prices and see that the long 100 put is worth $2.50, while the short 87 is fetching just $0.25. You sell off the first and buy back the latter and pocket an additional $225!
Total take on the effort is $765.
What About Losses?
As mentioned, your gains are capped on the upside at the short call strike, and your protection extends lower as far as the short put strike. After that, you enter the loss column, so it’s important to select a strike that’s far enough out of the money not to be triggered.
Good luck!
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