Who Should Use Equity Collars?
- an investor who is looking to limit the downside risk of a stock position at little or no cost
- an investor who is willing to forego upside potential in return for obtaining this downside protection
Equity collars are used by investors whose primary concern is the downside risk of a stock position. They are willing to place a cap on upside potential in order to limit their downside risk at little, and sometimes no cost. Collars may be of special interest to those investors who have one equity position that accounts for a large proportion of their net worth, and who may not be able to reduce the size of this position. For these investors, low cost protection may take precedence over maintaining upside potential.
An equity collar consists of the simultaneous purchase of a put option, and the writing of a call option. Both options are out-of-the-money, and usually have the same expiration date. Most often a collar is established against an existing equity position, with one put purchased and one call written for every 100 shares held. It is also possible to establish a collar at the same time that an equity position is purchased.