InvestorQ : Is the protective put same as a protective collar strategy in options?
Priyanka Jain made post

Is the protective put same as a protective collar strategy in options?

Answer
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Swati Naik answered.
2 years ago


A protective put is not the same as a protective collar although they are both related. For example, in a protective put you buy the stock and then buy a lower put option so that the downside is protected. But you still need to bear a put cost which can be quite high if the stock is not going to move up very sharply. Let us also look at a covered call. Here we sell a higher call but leave the downsides open. That is again dangerous. If we effectively combine a protective put and a covered call, we get a protective collar. So what you do in a protective call is that you buy the stock and then buy a lower put option to hedge the downside risk. But at the same time you also sell a higher call option. This means that the premium earned on the call reduces your cost of the put. However, remember that just as your downside risk is protected, your upside profit potential is also capped. Check the protective collar illustration below:

Bought RIL at Rs.1100 - Buy 1080 Put at Rs.20 and sell 1160 Call at Rs.8

Spot Price

RIL CMP

P/L on Spot

Buy Put Strike

ITM/OTM

Premium Paid

Put Value

P/L on Put

Sell Call Strike

ITM/OTM

Premium Recd.

Call Value

P/L on Call Sold

Total Profits

1100

900

-200

1080

ITM

-20

180

160

1160

OTM

8

0

8

-32

1100

920

-180

1080

ITM

-20

160

140

1160

OTM

8

0

8

-32

1100

940

-160

1080

ITM

-20

140

120

1160

OTM

8

0

8

-32

1100

960

-140

1080

ITM

-20

120

100

1160

OTM

8

0

8

-32

1100

980

-120

1080

ITM

-20

100

80

1160

OTM

8

0

8

-32

1100

1000

-100

1080

ITM

-20

80

60

1160

OTM

8

0

8

-32

1100

1020

-80

1080

ITM

-20

60

40

1160

OTM

8

0

8

-32

1100

1040

-60

1080

ITM

-20

40

20

1160

OTM

8

0

8

-32

1100

1060

-40

1080

ITM

-20

20

0

1160

OTM

8

0

8

-32

1100

1080

-20

1080

ATM

-20

0

-20

1160

OTM

8

0

8

-32

1100

1100

0

1080

OTM

-20

0

-20

1160

OTM

8

0

8

-12

1100

1120

20

1080

OTM

-20

0

-20

1160

OTM

8

0

8

8

1100

1140

40

1080

OTM

-20

0

-20

1160

OTM

8

0

8

28

1100

1160

60

1080

OTM

-20

0

-20

1160

ATM

8

0

8

48

1100

1180

80

1080

OTM

-20

0

-20

1160

ITM

8

-20

-12

48

1100

1200

100

1080

OTM

-20

0

-20

1160

ITM

8

-40

-32

48

1100

1220

120

1080

OTM

-20

0

-20

1160

ITM

8

-60

-52

48

1100

1240

140

1080

OTM

-20

0

-20

1160

ITM

8

-80

-72

48

1100

1260

160

1080

OTM

-20

0

-20

1160

ITM

8

-100

-92

48

1100

1280

180

1080

OTM

-20

0

-20

1160

ITM

8

-120

-112

48

1100

1300

200

1080

OTM

-20

0

-20

1160

ITM

8

-140

-132

48

Let us precisely understand how the collar above has been structured and what it does. There are 3 legs to this transaction. The stock has been purchased, a lower put has been bought and a higher call has been sold. This caps your downside risk and your upside profit potential. The maximum loss as you can see in the above table is Rs.32. Irrespective of how low the stock goes the maximum loss will remain at Rs.32 only. The maximum loss starts showing at the market price of Rs.1080 and remains the same below that. That is because you have bought the put at Rs.1080 strike. Below that, whatever you are losing on the stock you are gaining on the put option. Thus you become neutral below this point. How does the maximum loss of Rs.32 come? Rs.20 comes from the price difference between the spot purchase and the put strike (1100 – 1080). Then, Rs.12 is the net cost of the put option (20 – 8) since you also receive Rs.8 on the call sold. The total cost comes to Rs.32 (20 + 12). This is the maximum loss on the protective collar strategy.

How is the maximum profit of Rs.48 arrived at? As you can see the maximum profit on this collar arises at the price of Rs.1160, which is the strike at which you have written the call option. Thus your profit at that point on the spot position is Rs.60 (1160 – 1100). But from this you need to deduct the net cost of the collar which is Rs.12, as calculated above. That gives you a net profit of Rs.48 (60 – 12). That is the maximum profit on the collar. Above Rs.1160, whatever you earn on the spot position, you will lose on the short call option. That is how the protective collar is structured.