Another protective strategy that allows for some upside capital
gain while providing maximum down side protection is the collar.

The collar is a combination of the covered call and protective
put strategies. The collar uses a long put position in
coordination with a short call position along with a long stock
position. The ratio is one short call, one long put (not of the
same strike) and 100 shares of stock.

As you remember, one contract is equal to 100 shares. The
options that we will use to construct this strategy will be
out-of-the-money puts and calls.

The object here is to construct a protective put strategy
without having to pay for the purchase of the put. We talked
about premium in the covered call strategy and how we are better
off collecting premiums over a period of time, not paying them
out. By selling the call, we collect premium which can be used
to offset the capital outlay we incurred for the put purchase.

We said that two of three scenarios in the covered call strategy
were positive while the protective put scenario had only one
scenario that produced a positive outcome.
However, the protective put was the strategy that provided the
most downside protection. The challenge was to construct a
protective put strategy without paying out money. The solution
is the collar strategy.

The collar takes on the characteristics of both the protective
put and covered call strategies. Like the covered call, there is
an upside cap on profits and like the protective put there is
unlimited downside protection.

Ideally, the collar is set up to be an even trade meaning you
neither receive nor pay out any money. Realistically, depending
on the options used, you may have to pay out a small premium or
even receive a small premium but the goal of the collar in terms
of premium is to be neutral.

As mentioned previously, to construct a collar, just buy one
out-of-the-money put and sell one out-of-the-money call per
every 100 shares of stock owned.

Obviously, the put and the call must be of differing strikes (it
is impossible for a put and a call of identical strike price to
both to be out-of-the-money or both to be in-the-money).

For example, with a stock priced at $28.50 a collar may be
constructed by the purchase of the December 27.5 puts and the
sale of the December 30 calls. Hopefully, the price of the call
and put are close enough so that the funds generated by the sale
of the call are enough to offset the cost of the put purchase.