Would you like to protect your concentrated equity position from a decline in the stock price but reduce the up-front costs of hedging? An equity collar strategy uses put and call options to help you achieve this goal while retaining some, but not all, of your position's upside potential.
Create an equity collar hedge by purchasing a put option and selling a call.
When you sell a call option, you collect a premium for giving the buyer the right to buy the stock from you at a specified exercise (or strike) price. If the stock's market price rises above the strike price, you're obligated to sell the stock at the below-market price if the option is exercised.
When you purchase a put option, you gain the right, but not the obligation, to sell a security at a specified price.
Hedge your risk and avoid paying an upfront premium.
You can create an equity collar by purchasing a put with the strike price at or below the current stock price and selling a call with a strike price that exceeds the current stock price. This collar establishes a minimum and maximum value around your equity position for as long as the option contracts are in force. With a zero cost collar, you can structure the hedge so that the premium you generate from selling the call offsets the price you pay for the put option.
Take the uncertainty out of holding a concentrated stock position.
With an equity collar, you'll eliminate much of the inherent risk you face by holding a large position in a single stock. You'll be protected against downside risk below the put option price, although the opportunity for unlimited capital appreciation will be capped by the sale of the call option.