Reverse Collar Option Strategy

What are the characteristics of this option strategy?

Reverse collar is the label traders use for a collar wrapped around a stock position you already own. You buy an out-of-the-money put to put a floor under the position, and you sell an out-of-the-money call to help pay for that put. The two options use different strike prices and normally share an expiration date: the put sits below the current price, the call sits above it. Some desks reserve the name for the mirror image, run against a short stock position with a long call above and a short put below; the legs described here are the long stock version.

The result is a position with a defined floor and a defined ceiling. That is the trade-off worth understanding before you place it. You are giving up gains above the call strike in exchange for protection below the put strike. It is a hedge, not a source of free money, and it is not risk-free. You can still lose on the stock down to the put strike, and the net premium you pay widens that loss slightly.

Is this a bullish, bearish or neutral strategy?

Neutral to mildly bullish on the stock you hold, with a defensive posture. You keep the shares because you still want to own them, but you are willing to cap the upside to limit the downside.

Is this a beginner or an advanced option strategy?

Intermediate. The individual legs are simple, but choosing strikes and managing the position as expiration approaches takes judgment.

In what situation will I use this strategy?

When you hold a stock with a meaningful unrealised gain, you want to stay invested, and you want protection through a specific event such as an earnings release without selling the shares.

Where does this strategy typically fall in the range of risk-reward and probability of profit?

Both the maximum profit and the maximum loss are capped and known at the moment you open the trade. Probability of profit is high relative to holding the stock outright, because the put removes the tail, but the ceiling means you will underperform an unhedged position in a strong rally.

How is this strategy affected by the greeks?

Net delta is positive but lower than holding the stock alone, since the short call and long put both offset it. The short call carries negative gamma, so net delta falls toward zero as the stock pushes through the call strike and your gains stop accruing there; the cost is forgone upside rather than an accelerating loss. Time decay works in your favour on the short call and against you on the long put, so the net theta depends on which leg is closer to the money.

In what volatility regime (i.e. VIX level) would this strategy be optimal?

Elevated implied volatility helps, because the call you sell is worth more, which offsets more of the put's cost. In a very low volatility regime the put is cheap but the call brings in little, so the collar costs more on a net basis.

How do I adjust this strategy when the trade goes against me?

The collar is one of the easier positions to adjust. You can roll both legs out in time, raise the put strike to lock in more of a gain, or raise the call strike to reclaim some upside, though raising the call strike costs money.

Where does this strategy typically fall in the range of commissions and fees?

Two legs, so two commissions, plus a third if you are also buying the stock. Because the short call funds much of the long put, the net cash outlay is usually small, but the commission cost is the same as any two-leg position.

Is this a good option income strategy?

No. The premium from the call is paying for the put, not landing in your pocket. If income is the goal, a covered call on its own keeps the premium, at the cost of having no downside protection.

How do I know when to exit this strategy?

Common exits are at expiration, when the event you were hedging has passed, or when the stock approaches the call strike and you would rather close than be assigned. If implied volatility collapses shortly after you open the position, the put loses value quickly and the hedge becomes expensive relative to what it now protects.

How will market makers respond to this trade being opened?

A collar is a routine two-leg order and fills without difficulty in liquid names. Spreads widen in less liquid underlyings, so check the bid-ask on both legs before sending the order.

What is an example (with calculations) of this strategy?

You own 100 shares of MSFT, bought at $285. You want protection into an uncertain quarter without selling.

• Buy 1 put, strike $270, premium $4.00 per share, cost $400
• Sell 1 call, strike $300, premium $3.00 per share, credit $300

Net premium is a debit of $1.00 per share, or $100 for the contract. Note that you pay here: the call does not fully cover the put, which is the usual case when the put is closer to the money.

That gives:

• Breakeven: $285 + $1.00 = $286.00
• Maximum loss: $285 − $270 + $1.00 = $16.00 per share, or $1,600, no matter how far MSFT falls
• Maximum profit: $300 − $285 − $1.00 = $14.00 per share, or $1,400, no matter how far MSFT rises

Three outcomes at expiration:

• Below $270. The put lets you sell at $270. Your loss stops at $16 per share.
• Above $300. The call is assigned and you sell at $300. Your gain stops at $14 per share.
• Between $270 and $300. Both options expire worthless. You keep the shares and you are out the $1.00 net premium, so your result is the stock's move minus $1.00.

Notice that the maximum loss here is larger than the maximum gain. That is normal for a collar where the put is nearer the money than the call, and it is exactly the number to check before placing the trade: if the shape of that trade-off does not suit you, move the strikes.

MarketXLS

MarketXLS provides real-time options data and analytics inside Excel, so you can price a collar, compare strike combinations and see the payoff for a position like the one above against live quotes rather than static examples.

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