Collar Strategy is when an investor buys the underlying security and simultaneously sells an out of the money call and buys an at the money put of the same underlying and same expiry.
When to use this strategy?
This strategy is used when the investor is moderately bullish.
Such a strategy is beneficial for an investor who wishes to be protected against a sharp drop in price of the underlying security while simulataneously trying to earn premiums by selling OTM calls.
How to build this strategy?
This strategy has three legs:
Leg 1 – Buy the underlying security, quantity being equivalent to the lot size of the options contract.
Leg 2 – Sell 1 OTM Call
Leg 3 – Buy 1 OTM Put
Credit Spread/Debit Spread
This depends on the price of the call and put options.
If the premium of the call option is higher than the put option, then such a strategy would be a credit spread.
If the premium of the call option is lower than the put option, then such a strategy would be a debit spread.
The profit potential of this strategy is limited.
When is this strategy profitable?
The investor makes maximum profit when the underlying security’s price is greater than or equal to the strike price of the call option sold.
The investor faces limited risk in this strategy.
When is this strategy unprofitable?
The investor faces maximum loss when the underlying security’s prices are less than or equal to the strike price of put option purchased.