Protect Your Stocks Using Put Options - The Collar Strategy
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In a bull market there’s a good chance that a stock that you have picked, using some selection process, will increase in value. This is what the average stock picker does, they buy stocks then hope (and often pray) that they go up.
Statistics show that in a bull market about 75% of the stocks will follow the general trend and go up, and in a bear market 75% will also go down. Trading with the trend is the best way to trade as 9 out of 12 stocks will follow the trend and give you the best chance of making gains on your stock purchases.
But what if you own some good stocks and don’t want to sell when the market is clearly going down, or about to go down?. There are a couple of tactics that you can consider, both of which involve the use of options, CALL options and PUT options. There is the widely known strategy called Covered Calls, and the much lesser known one called the Married Put.
If you are going to trade options it is essential that before you start trading you get the best option trading education that you can. This is a very important point that must be taken seriously, if you don’t understand the terminology and theory then you should not be trading options. If Put option, Call option, Married Put and Covered Call are new to you then don’t trade until you have studied sufficiently.
The Covered Call strategy involves selling call options against the stock the you already own, in 100 share blocks. If the stock goes down the call options lose their value and compensate you in part for the loss in the stock price. However if the stock goes down by more than about 3-5% then you will lose more money in the stock than gained using the call option.
As already mentioned the covered call system only has the potential to offer about 4-7% credit when the stock goes down. Stocks have been known to quickly lose anything from 10 to 30% in a matter of days or weeks and the covered call strategy offers little protection against this sort of loss.
The better solution to providing downside stock protection is the option strategy called the Married Put. As the name suggests the PUT that you buy is used to provide protection when the stock goes down because Put options increase in value when the stock decreases in value. The term married is used because the option that is selected has to be very compatible with the stock, in other words a good match, if the strategy is to work.
There are a number of parameters that need to be considered when creating a Married Put for protection, the following list highlights the main points:
1. The PUT strike price
2. The current stock price
3. Either in or out of the money Put options
4. How much option time you want to buy
The last point is very important because the Put options that you buy only have a limited life and you need to consider for how long you need the protection. The big advantage of the Married Put strategy over the Covered Call strategy is that if selected correctly it can provide 90-95% loss protection in the event of a large drop in the stock price.
The cost of the PUT is a disadvantage of this strategy if you take a shortsighted approach. There are ways of offsetting this option cost when this strategy is taken to the next level. When traded correctly, with the right stock, the expense of the Put can be offset and good returns can be made when others are loosing their shirts.
The general idea of the Collar Trade is to combine the covered call and married Put strategy into one, this is what is called the Collar Trade. In effect you put a collar around the stock, sell a call and buy a PUT. If you do this correctly most of the cost of the Put can be offset by the credit from the covered call so you can protect your valuable stock at almost no cost. Yes this is a great strategy which the general public is unfortunately very ignorant of, and most brokers don’t understand.
