In options, a collar is a combination of a protective put and a covered call. protective put = buy stock, buy put covered call = buy stock, sell call now does this mean that you have bought two units of stock? is the total strategy equivalent to 2 units of stock, long a put, short a call?

no, in collar it is assumed you are already holding the stock, so all you do is bying a put and selling a call

schweser describes collar as combo of protective put and covered call.

you can think of it in terms of protective put and covered call, but to construct a collar you don’t physically execute full protective put and covered call transactions

so please confirm that i only have one unit of stock. thanks.

Yes 1 unit of stock.

you buy enough puts and sell enough calls to hedge your position in normal circumstances. but in the case of a constructive sale (i.e. low basis stock) you lock in a collar on only 85% of your posiiton in order to avoid the IRS saying you’ve constructively sold your low basis holding.

yep 1 put, 1 stock (or any other underlying), and 1 call

What’s the Max Gain and Loss from a Collar strategy?

assuming you hedge 100% of your underlying, max gain is from your current asset value to the strike price on the call and max loss is the difference between the strike on the put and your current asset value. add to these max gain/loss the total premium paid to set up the collar and you have your answer.

Why would someone want to enter into a collar strategy?

to hedge downside of your stock “for free”, as you offset the cost of the put with the premium you get for selling the call I guess other ones (HFs) will also want to “play” with the skew quoted in the collar (difference between volatility priced in the call and volatility priced in the put), but I guess this is way beyond exam purposes

Why would someone?? Well, say I have a pension plan and my goal is 8% and it’s September and I’m up 12%, I might by a zero-cost collar to protect my 12% return from any downside that might occur in the last few months of the year…I wont participate in much upside but I will protect myself from not meeting my goals…

Excellent description bigwilly.

ooo I like “Excellent” :slight_smile:

P + C + S = Collar, you wouldn’t have a hedge by using 2 shares, you’d have to double your option content.

Yeah, I think of a collar as buying a put and selling a call, and arranging it so that the premium from the call pays for or reduces the price of the put. I guess Schwesser calls it a covered call + protective put because the covered call gains you a premium without much risk (you just loose the upside above the call’s strike), and the protective put protects you from downside. So yes, to do a collar you don’t need to have two units of the underlying (in fact, it won’t work if you do). You just need one unit of underlying per call and put. The basic strategy is to protect your downside by buying a put. Normally that’d be great, but you have to pay up a premium for the put. So you can do that, or you can sell off some of your upside by selling a call with a higher strike price and use that premium to pay for your put, so then, net, you don’t have to fork out a premium or as much of one. So that’s why you’d use a collar instead of just a protective put.

In my opinion: only 1 unit of stock. 1 stock + 1 put and (-1)call.