Collar Option
A collar option investment strategy involves the purchasing of a
protective put and writing a covered call by an investor, who
already holds the underlying stock. Generally, both the put and
call options have the same expiration period but with different
exercise prices. In a collar option strategy, both the put and
call option contracts are out of the money. This strategy limits
both the upside potential and the downside risk of the
investors. This strategy is employed when the investors want to
limit their downside risk. They know that the stock price may
not increase rapidly but wish to sell the stock at price more
than the current market price.
Example:
The stock of Tata Engineering Ltd. is trading at Rs. 62 a share.
A buys 100 shares at Rs 62 per share and purchases an out of
money put option at the exercise price of Rs. 57 per share, the
option premium being Rs. 2.50 per share. The contract expires
three months later in March 2002. A also writes a call option
contract which expires in the same month at the exercise price
of Rs. 69 a share. The option premium received is Rs. 2.50 per
share. A has adopted the collar option strategy and will have
the following cash flows:
Buy 100 shares of Tata at Rs. 62 per share = Rs. (6200)
Buy March Rs. 57 Put option contract
at Rs. 2.50 per share = Rs. (250)
Sell March Rs. 69 Call option contract
at Rs. 2.50 per share = Rs. 250
Total cost Rs. 6200
Max. Loss Rs. 500
Max. Profit Rs. 700
In the above example, the investor will experience maximum loss
if the stock price falls to or below Rs. 57 per share at the
time of expiration, while he would realize the maximum profit if
the stock price exceeds or is equal to Rs. 69 a share.
Box Spread
A box spread involves the usage of both the bull and bear
spreads with call and put options contract having the same set
of exercise prices. A box spread can be created by purchasing a
bull spread (buying a call at a lower exercise price and selling
a call at a higher exercise price) and a bear spread (buying a
put at a higher exercise price and selling a put with lower
exercise price). This strategy is basically designed for
investors who do not wish to take much risk as it gives a
constant payoff, that is, the difference between the higher and
lower exercise prices. |
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