The Collar Strategy Can Protect Your Stocks Using Put Options
James J. Dehoiver
In a bull market there's a good chance that a stock that you have picked, using some selection process, will increase in value. This is what the average stock picker does, they buy stocks then hope (and often pray) that they go up.
Statistics show that in a bull market about 75% of the stocks will follow the general trend and go up, and in a bear market 75% will also go down. Trading with the trend is the best way to trade as 9 out of 12 stocks will follow the trend and give you the best chance of making gains on your stock purchases.
Even in a clear bear market there are reasons why some investors would not want to sell their stocks, this could be for tax problems or because they inherited the stock from a relative. Without taking some action they could suffer a large loss, but fortunatley by using options some downside protection can be obtained. Using Call and Put options in two strategies called Covered Call and the Married Put the losses can be limited.
If you are going to trade options it is essential that before you start trading you get the best option trading education that you can. This is a very important point that must be taken seriously, if you don't understand the terminology and theory then you should not be trading options. If Put option, Call option, Married Put and Covered Call are new to you then don't trade until you have studied sufficiently.
Call options are bought and sold in 100 share blocks, this is 1 option contract. When doing a covered call you sell 1 call option contract for every 100 shares that you own. The value of the call option will go down if the stock goes down, giving you the chance to either let it expire worthless or buy it back at a much cheaper price. Either way you can get about 4-6% downside protection, but if the stock decreases more than this then you will have to take a loss.
As already mentioned the covered call system only has the potential to offer about 4-7% credit when the stock goes down. Stocks have been known to quickly lose anything from 10 to 30% in a matter of days or weeks and the covered call strategy offers little protection against this sort of loss.
The Married Put is the prefered way of protecting stocks, over the covered call, this is because it offers much larger protection. As the stock goes down, the Put will gain rapidly in value depending on it's delta value and strike price, these have to be selected carefully to match the stock, hence the term married Put.
It is beyond the scope of this article to explain exactly which Put option to buy but the following parameters need to be considered:
1. What strike price is selected for the Put option
2. The price of the stock
3. Choice of options, in or out of the money
4. How much option time you want to buy
The last point is very important because the Put options that you buy only have a limited life and you need to consider for how long you need the protection. The big advantage of the Married Put strategy over the Covered Call strategy is that if selected correctly it can provide 90-95% loss protection in the event of a large drop in the stock price.
The downside of the good protection is that you have buy the Put which is a debit whereas the covered call is a credit. But there are ways of offsetting this expense and there is much more to this strategy when executed correctly. The Married Put can be made to pay for itself and used to generate very good gains if the market, or stock to be specific, moves a lot.
The general idea of the Collar Trade is to combine the covered call and married Put strategy into one, this is what is called the Collar Trade. In effect you put a collar around the stock, sell a call and buy a PUT. If you do this correctly most of the cost of the Put can be offset by the credit from the covered call so you can protect your valuable stock at almost no cost. Yes this is a great strategy which the general public is unfortunately very ignorant of, and most brokers don't understand.
James J. Dehoiver is an experianced stock investor, he also loves to
http://www.myedollars.com/ learn stock trading systems and master the best
http://www.myedollars.com/technical-indicators.htm) technical indicators for stock investors.
