The Collar Option as an Option Trading Strategy

I started trading covered calls in 1999. At that time, the internet bubble was expanding and option premiums were high. Yahoo stock traded as high as $445 per share intra-day with calls for the stock to go over $1000 per share. As I soon learned, the risk of buying stocks solely for the purpose of collecting high premiums is that if the stock declines significantly the loss of capital outweighs the premium income. It is still possible to lose a bundle. Fortunately for me, I did not learn that lesson with Yahoo stock, but it was painful enough.

I kept learning about options, reading everything I could get my hands on and purchasing books when I could.  I felt that there had to be a better way of trading options that wasn’t so risky to one’s capital.  In my readings, I also got the feeling the inflation was potentially a big concern and began investing in energy and especially in gold (but that is another story).  I continued to sell covered calls against stocks in my retirement account making a little money and losing some, searching for a better way.

Then in October of 2006, it hit me.  Why not continue to sell covered calls but buy a protective put to at least protect my capital?  I could purchase an out-of-the-money put and sell an at-the-money call keeping the difference in the premiums.  I went to the options chain for the stocks I held at the time and discovered that it was indeed a feasible strategy.  I would no longer have to worry about a major gap down in any of the stocks that I held.  I could generate some cash in my account while protecting it from disaster.  I thought I had discovered sliced bread but as I searched the internet found that this actually had a name:  COLLAR!

I was shocked!  Why had there never been anything written about this in my option books.  There were lots of books on covered calls but nothing on collars.  I actually found a book on the internet and paid $300 for it, but it was one of the greatest investments I have ever made.

I began trading collars in my retirement account in January of 2007 and have done so ever since.  I don’t always sell covered calls against all the stocks so many times I actually have protective puts in place.  That is probably a mistake.  I am learning that it is probably better to generate the cash for the account rather than rely on capital gains.  I am planning to work on generating more cash over the next year or so and see how that goes.  That was one of the reasons that I lost 18% on my retirement account in 2008 versus the market’s 36%.  I would have been even better off had I sold more calls and not been overly optimistic.  But I continue to learn and modify my techniques.

As an option trading strategy, I am using collars to generate cash on a monthly basis and using puts to protect my capital.  If the stock declines significantly, I am using the profits from the puts to increase my share count and build my position in the stock so that I can generate increasing levels of cash.  In the link below, I have included the article that really got me started in collars (once I learned what they were called) and alerted me to the possibilities.  Of course, you should trade in a way that matches your personality.  When it is all said and done, equity collars seem to fit me pretty well.