Visually construct and analyze options strategies


Options Strategy - Collar


If the strike price of the two options is the same, a Long Call/Short Put position is equivalent to a Long Stock position. However, this strategy is often designed using options with two different strikes. For example, with XYZ at $60, the investor would build the spread using the 65 Call and the 60 Put (A.K.A. - Collar).

When to use

Because this position is either equivalent to long stock (same strike price) or closely approximates long stock (split strikes), the investor utilizing this strategy must be aware of its risk/reward profile. (Unlimited risk and unlimited reward!) This strategy is most often used when XYZ is near the mid-point between the two split strike prices. First, the spread is often established for little or no debit. And secondly, it provides a little room for XYZ to decline before the Put becomes in-the-money.

Risk/Reward Characteristics

Like Long Stock, the spread's potential is unlimited. Losses are unlimited because the investor could end up with a long stock position if assigned on the short Put. Because of this fact, the investor must carefully consider the initial size of the spread!

Break-even Point: If debit spread: Call strike price + spread debit; If credit spread: Put strike price - spread credit

Time Decay: Varies. If XYZ is near Long Call strike price, time decay is a negative for the spread. If XYX is near Short Put, time decay is a positive.

Volatility: Neutral. If volatility increases, both options increase in price. Thus, the gain in the Call offsets the loss in the Put. If volatility decreases, the gain in the Put offsets the loss in the Call.

Assignment Risk: The investor must watch XYZ for possible assignment if XYZ declines below the Put's strike.

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