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Option Collar Options: Rolling Up, Rolling Down, Rolling Out ...

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January 4, 2018
Adjusting collars: Options for protecting or accumulating long options positions
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A previous article explored how options collars can help protect long stock positions while allowing the stock to appreciate in price by a limited amount. We showed how the put option attempts to provide protection, acting like a floor; and how the put can be paid for by selling a call option, which acts like a ceiling.

We also showed how, if the stock goes higher, you can adjust the floor and the ceiling higher. This can allow the stock more room to appreciate in price without leaving the floor too far below the stock’s current price. But what if the stock goes the other way?

The Stock Goes Down; Now What?

When we left our example in the previous article, the position consisted of:

  • Long 100 shares of the stock, which was trading at $105
  • Short one call option contract at the 110 strike
  • Long one put option contract at the 100 strike

This is known as the “100-110 collar.” And remember, the multiplier for standard equity options is 100, and the contract size is 100 shares.

Now, suppose the stock goes lower, like, a lot lower. Suppose the company releases bad news and the stock drops to $90.

You could buy the 110-strike call to close, exercise your 100-strike put, and move on, thankful that you had some downside protection. Or, if you think the stock has found a bottom—at least in the short term—and could start moving higher again, then you might decide to reset your collar.

Using the theoretical option prices from the table below, let’s say you roll the 100-strike put, which has gone in-the-money (ITM), down to the 85 strike, which is out-of-the-money (OTM). You can use a short vertical put spread order to sell your 100-strike put and buy the 85-strike put for a net credit of $9.20 ($10 – $0.80). Then, you’d buy the 110 call and sell the 95 call, which can be done using a short vertical call spread order for a credit of $0.55.

Stock = $90

Call Bid
Call Ask
Strike
Put Bid
Put Ask
$10.10
$10.50
80
$0.25
$0.30
$5.80
$6.10
85
$0.70
$0.80 (Buy)
$2.40
$2.50
90
$2.35
$2.45
$0.60 (Sell)
$0.65
95
$5.60
$5.90
$0.10
$0.15
100
$10.00 (Sell)
$10.40
0
$0.05
105
$14.90
$15.50
0
$0.05 (Buy)
110
$19.90
$20.50
TABLE 1: SAMPLE OPTION CHAIN. Theoretical prices for options with the stock at $90.   For illustrative purposes only.

These two adjustments net a credit of ($9.20 + $0.55) = $9.75, times the multiplier of 100, for a total of $975, less transaction costs. And since there are four legs to this adjustment, those transaction costs can add up. Plus, although you took in a credit to roll the collar down, you also have a stock that’s quite a bit lower than it was before. Is that a good or a bad thing? It depends on your objectives. If you still view the stock as a “buy,” you might decide to add to your collar.

Using Collars to Scale Into, or Add to, a Stock Position

We’ve been looking at collaring 100 shares of stock. But what if you’re collaring 1,000 shares? That would mean you have 10 collars, and the credit in this adjustment example would be $9,750 (less transaction costs). Some traders might use this credit to purchase additional shares of stock and increase the number of collars they’re trading. Here, with the stock trading at $90, the credit could potentially be used to buy an additional 100 shares of the underlying and one more collar.

So let’s take this example this one step further by assuming you started with 1,000 shares of stock and 10 collars, but you’ve now increased that to 1,100 shares that are collared with long 11 of the 85 puts and short 11 of the 95 calls. Now, after a couple weeks, the stock heads higher again and goes to $94.

Stock = $94

20 Days to Expiration
Call Bid
Call Ask
Strike
Put Bid
Put Ask

$9.00
$9.50
85
$0.20 (Sell)
$0.30

$4.70
$5.00
90
$0.85
$0.95 (Buy)

$1.25
$1.35 (Buy)
95
$2.20
$2.35

$0.15
$0.25
100
$6.00
$6.30

0
$0.15
105
$11.00
$11.40
41 Days to Expiration
Call Bid
Call Ask
Strike
Put Bid
Put Ask

$5.80
$6.10
90
$1.55
$1.65

$2.10
$2.25
95
$3.05
$3.20

$1.40 (Sell)
$1.50
100
$7.20
$7.60

$0.70
$0.80
105
$11.50
$12.00
TABLE 2. SAMPLE OPTION CHAIN. Theoretical prices for options in two expirations (one with 20 days until expiration and another with 41 days left) and the stock at $94.   For illustrative purposes only. 

In this theoretical example, you can adjust the collar higher since the stock has moved up. Using the 20-day sample option prices in Table 2, you could, for example, roll the 85 put up to the 90 strike using a long vertical put spread for a debit of $0.75 ($0.95 – $0.20). As for the short 95 call, you might decide to wait it out and see if the stock remains below the strike at expiration. But understand the risk of assignment—you may be required to sell your stock, and assignment commissions are higher than regular commissions.  

Let's look at the flipside: after you added to your position, the stock might not have rallied, but rather stayed at $90, or even fallen further. This would have compounded your loss. Plus, each time you roll a position, you incur additional transaction costs.

Some option traders might opt to roll the call to a deferred-month expiration date, which, in this example, has 41 days left. You could roll out to that expiration by buying the short 95-strike call and selling the deferred-month 100-strike call. In this example, you would get a 5-cent credit ($1.40 – $1.35). You’d have to wait longer for the call to expire, but you’ve given the stock room to appreciate, or, in trader parlance, “raised the ceiling.”

If your stock moves higher, you can look to adjust the strikes to raise both the floor and the ceiling. If the stock price falls further, you can decide whether you want to adjust your collar and begin the process again.

Once again, it’s all about your objectives, that is, your outlook on the underlying stock. Collars can provide that floor and ceiling, and can be a strategy to scale a position, but you need to understand the trade-offs and the risks.

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