Options Strategy: The Installment Collar

The collar can be expanded to create a truly creative variety. The traditional collar (own 100 shares, sell 1 covered call, and buy 1 put) can be turned into a long-term protective version:

  • buy 100 shares
  • sell one very short-term covered call, maximizing annualized income as the result of time decay, picking a strike higher than the cost of your stock
  • buy one long-term put (8-10 months)

This accomplishes a relatively high rate of return without the need to replace the put. The short call expires or is closed and then replaced as many times as possible. This should more than pay for the relatively rich long put, but on the installment plan. A one-month call could be opened and expired up to 8-10 times over 8-10 months.

Meanwhile, you get the insurance protection against downside risk. If the stock price falls so that the long put goes in the money, its value increases one dollar for each point lost in the stock, limiting downside risk.

Because the put is paid for on the installment plan, it doesn’t really matter how time decay happens. The net outcome is a wash between long put and short call. This is a no-cost or low-cost way to get the insurance put but without having to turn over the collar frequently.

Ideally, you get the downside protection, and over time the short call premium and dividends more than pay for the put.

If the stock price falls below the put’s strike, exercise the put, and immediately replace the stock and the put. This should be done immediately to avoid being required to post collateral for the short call, which is uncovered after you exercise the long put and sell stock.

The proceeds from disposing of stock should pay for replacement stock as well as a new long put. This is because you exercise at a price above current market value and then purchase replacement shares at market value. The net profit on this transaction should pay for the new put; in fact, you can select a put based on the amount of net profit available, representing the difference between the exercise strike and current value of stock.

If the stock price rises above the call’s strike, you can accept exercise, which will be profitable as long as the strike is higher than your basis in the stock. This leaves you with only the long put. As long as the call or series of calls written is profitable after exercise, this is also a positive outcome. Following this, you can purchase another 100 shares and sell a call, recreating the position; or you can just track the long put based on the possibility of eventual profit if and when the stock price declines.

Exercise can also be avoided when the call moves close to or in the money, by rolling it forward. This should set up a new net credit at the same strike. In ideal circumstances, you will be able to roll forward to a higher strike, so that even with exercise in the future, the stock profit will be increased as well.

This strategy is flexible and has many possible outcomes. Of course it is possible to set up a loss, but as long as the strikes are picked well and all positions are monitored, it should yield profits over time while eliminating the stock’s market risk; and because the short call is covered, there is no requirement for collateral to be kept on deposit.