Protective Index Collars Summary

For those investors holding a portfolio of mixed stocks who have unrealized profits to protect, an index collar might be an appropriate strategy to consider. Purchasing index put options with a given strike price for downside protection can, at least in part, be financed by the simultaneous sale of the same number of calls with a higher strike price. The written calls will, however, cap potential upside profits on the portfolio if the investor is assigned on these short contracts.

When the decision is made to use a collar, the investor should at first select an index that best tracks the performance of that portfolio and establish the collar position with its overlying options. Then the investor considers the value of the portfolio and the current level of the index chosen to determine the number of options to buy and sell. A put strike price is chosen that provides the degree of downside protection wanted, and a call strike price is selected that caps upside profit at an amount that is tolerable as a trade-off for the downside portfolio insurance provided by the puts.

Today's investor has a choice of shorter-term expiration months afforded by regular index option contracts, longer-term expirations available with LEAPS®, as well as multiple strike prices. So no matter an investor's anticipated target for downside protection in return for capped upside profits, there are most likely put and call contracts that fit both of these parameters.