A Collar Trade is typically formed around a long stock position. The long stock can be used to cover a long term short call, with a long protective ATM put. E.g., 1,000 shares of XYZ, short 10 XYZ DEC call options, protected by 10 long XYZ DEC puts, at the money. In some cases, the cost of the put is covered by the credit from the short – but not always. This trade will make money no matter which way the market moves, and requires very little maintenance effort.
Collars are very conservative, and have the disadvantage of requiring a lot of capital. They are favored by those with relatively large accounts. For us more ordinary folks, it would be nice to have a conservative trade that could be laid on in an account with fewer funds available. So why not consider a collar made entirely of options? A synthetic collar.
If we substitute LEAPS (Long term Equity Anticipation) for the stock, we make our working capital go further. Using GLD as an example, 10 JAN 13 LEAP contracts with a delta of 71%, gives us control of 1,000 shares of GLD costing $27,563 in buying power. 1,000 GLD shares would cost about $148,330 to buy, a saving of about 81%. The LEAP, with a delta of 71% does a pretty good job of mimicking the underlying equity. In a rising market, the delta will creep up toward 100%.
We could sell short calls against these 10 long contracts, gaining income. I would favor the use of the weekly series, but the regular monthly options require less maintenance effort. If the market is going sideways or down, I’d add +10 GLD OCT 11 puts ATM for protection. Depending on the market you might safely omit the put and save premium. If you go for the put, it could be rolled forward every quarter, adjusting the strike to keep it at or near the money. When no longer needed, it can be sold to recover residual premium value. A couple of months before the LEAP expires, it can be sold for a profit, or rolled out a year, adjusting the strike for a delta of at least 70%.
Collar trades are an attractive way to stay in the market while you enjoy that month long European vacation.