The Collar Strategy is a risk management strategy used to protect investors from the impact of a significant downturn in the stock market. This strategy involves simultaneously holding stocks, buying protective put options, and selling call options. This article will introduce the basic concepts and operation of the Collar Strategy, demonstrate its application through a practical case, and finally provide a corresponding profit and loss graph analysis.

Overview of the Collar Strategy

The Collar Strategy consists of two parts: buying protective put options to safeguard against the risk of a stock price decline and selling call options to generate premiums while limiting the potential gains when the stock rises. This strategy is suitable for investors who wish to provide a certain degree of protection for their held stocks.

Principle of the Strategy

1. Hold Stocks:Investors hold a certain stock.
2. Buy Protective Put Options:Investors purchase put options to protect against the risk of a decline in the stock price.
3. Sell Call Options:Simultaneously, to offset the cost of the put options, investors sell call options.

Profit and Loss Characteristics

1. Maximum Profit:The profit occurs when the stock price rises to the execution price of the call option. This profit is the sum of the premium received from selling the call option and subtracting the premium paid for the put option.
2. Maximum Loss:The loss occurs when the stock price drops to the execution price of the put option. This loss is the sum of the premium paid for the put option minus the premium received from selling the call option.
3. Breakeven Point:The current stock price plus the premium paid for the put option, minus the premium received from selling the call option.

Practical Case

Assuming an investor holds stock H with a price of $100 per share and adopts the Collar Strategy by:

• Buying a put optionwith an execution price of $95, paying a premium of $3.
• Selling a call optionwith an execution price of $105, receiving a premium of $2.

Then:

• Maximum Profit:Occurs when the stock price is equal to or exceeds $105, resulting in $105 - $100 + $2 - $3 = $4.
• Maximum Loss:Occurs when the stock price is equal to or falls below $95, resulting in $100 - $95 + $3 - $2 = $6.
• Breakeven Point:Approximately $100 + $3 - $2 = $101.

Next, I will draw the profit and loss graph based on these parameters.

This chart now more accurately depicts the profit and loss situation of the Collar Strategy. From the chart, it can be observed that:

• When the stock price is below $95 (indicated by the green dashed line), the strategy's losses are limited to a fixed value (represented by the horizontal line in pink). This is because the purchased put option provides downside protection.
• When the stock price is between $95 and $105, the strategy's profit and loss vary with changes in the stock price, but due to the impact of the purchased put option and the sold call option, both gains and losses are limited.
• When the stock price is above $105 (indicated by the red dashed line), the strategy's profits are restricted to a fixed value (represented by the horizontal line in orange). This is because the sold call option limits the upside profit potential.

The Collar Strategy, through the purchase of put options and the sale of call options, provides both upward and downward price protection for stock investments. This strategy is suitable for investors who wish to reduce price volatility risk while maintaining their stock investments. Through this strategy, investors can to some extent control the risk and return characteristics of their investment portfolio.

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