Bryan Perry

Use Option Collars to Button Up Gains

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I love trading both calls and puts, because you can profit from stocks, and the market, whether they're coming or going -- although it's hard for me to wrap my head around the idea that a lot of people want to shy away from trading puts. After all, using put options to protect a stock position is like purchasing a life insurance policy.

A put becomes profitable if the stock drops in value, and I've heard folks grouse that they "wasted" their money on a protective put because the stock didn't go down. Huh?! It's not like you buy a life insurance policy and say, "Damn! I didn't die and get to cash it in!" You should just be glad that you had the protection in place and didn't need it!

LONGER-TERM PUTS CAN EQUAL SHORTER-TERM PEACE OF MIND

One of my favorite strategies is called a "collar," and it's pretty much what it sounds like -- using your head by not sticking out your neck. A collar trade is a spread strategy that helps you to preserve profits on a stock that's made some significant gains.

Because we're looking to buy protection, we're buying put options as the first half of the trade. But the second half of the trade (as a spread is a two-legged trade) encompasses selling call options against those long puts. Both options should be out-of-the-money, so that means the market price of the stock should be lower than the put option's strike and higher for the call option's strike.

For example, a stock that keeps on moving upward is Apple (AAPL). To "collar" a 1,000-share position in AAPL, which is trading at $181, you could:

Buy 10 AAPL Jan (2009) 180 Puts, and

Sell 10 AAPL Jan (2008) 195 Calls

Notice that I went all the way out into 2009 for the January puts at the $180 strike price. Not only does the long put position protect us from a downward move as AAPL moves up, but it does so for a year.

When we're simply buying options, particularly calls, we're usually looking to profit from a quick move in the near term. But when we're buying protection, it makes sense to buy as much time as we can!

GET 'SOLD' ON THE IDEA OF SELLING CALLS AGAINST YOUR PUTS

That brings me to the call options that we will sell to open. Those calls at the $195 strike represent the share price we want to ride AAPL up to.

Notice that we've gone with calls that have a closer expiration date. The goal with the collar strategy is to collect premium from those short calls every month or so as you're riding this trade till the later expiration date of the puts.