When you’re trading options, there are a variety of different strategies you can use to make profits. One of those strategies is the protective collar.
The protective collar is a strategy that uses puts and calls to help protect an investor’s downside risk while still allowing for some potential upside profit. The goal of the protective collar is to limit the amount of money lost if the stock price drops while also allowing for a better return if the stock price rises.
The two main components of the protective collar
The protective collar has two main components: the long put and the short call. The long put gives you protection against a drop in the stock price, while the short call introduces some limited upside potential.
Here’s how it works
You buy a put option with a strike price below the current stock price. This gives you the right to sell the stock at that strike price, no matter how low the stock price falls. At the same time, you also sell a call option with a strike price above the current stock price. This limits your upside potential, but it also helps offset the cost of buying the put option.
If the stock price falls below the put option’s strike price, you can exercise your option and sell the stock at that price. This will help limit your losses if the stock price falls sharply. If the stock price rises above the strike price of the call option, you can let that option expire worthlessly and keep any profits you’ve made on the rise in the stock price.
The downside of the protective collar
The main downside of the protective collar is that it limits your upside potential. If the stock price rises sharply, you won’t participate in those gains. But for investors who are worried about a sharp drop in the stock price, the protective collar can be a helpful way to limit risk.
A few things to consider when using a protective collar trade
There are a few different things to consider when implementing a protective collar trade. The most important is the expiration date of the options involved. You want to ensure that the put option you buy will expire before the call option you sell. This ensures that you are not forced to sell the underlying asset at a price below where it is currently trading.
Another thing to consider is the cost of the options. The put option should be cheaper than the call option, as this will limit your potential profits if the stock price rises. It would help if you also were mindful of your maximum loss on the trade. If the underlying asset falls to zero, this is the amount you could lose.
The pros and cons to using a protective collar strategy
There are some pros and cons to using a protective collar strategy. On the one hand, it can help limit your downside risk. On the other hand, it also limits your potential upside profit. As with any option strategy, it is important to understand how it works before implementing it in your trading.
Bottom Line
Trading options can be a profitable way to invest, but it is important to understand the risks involved. The protective collar strategy is one way to help limit those risks while still allowing for some potential upside profit. By understanding how this strategy works, you can decide if it is right for you. If you’re interested in trying out the protective collar strategy, be sure to work with a reputable and experienced online broker from Saxo Bank to help you get started. They can help you choose the right options and decide when to enter and exit your positions. And most importantly, they can help you manage your risk so that you don’t lose more money than you’re comfortable with. For more information, visit their site here.
