Intermediate Options Strategies: Collar - Conclusion
...Continued From Part Two.
If the underlying stock price is between the strike prices of the call and put when the options expire, both options will generally expire with no value.
In this case, the investor will lose the entire net premium paid when establishing the combination, or keep the entire net cash credit received when establishing the combination. Balance either result with the underlying stock profits accrued when the spread was established.
In this example, the investor is protecting his accrued profits from the underlying stock with a sale price for the shares guaranteed at the long put’s strike price. In this case, consideration of BEP does not apply.
If Volatility Increases: Effect Varies
If Volatility Decreases: Effect Varies
The effect of an increase or decrease in the volatility of the underlying stock may be noticed in the time value portion of the options’ premiums. The net effect on the strategy will depend on whether the long and/or short options are in-the-money or out-of-the-money, and the time remaining until expiration.
Passage of Time: Effect Varies
The effect of time decay on this strategy varies with the underlying stock’s price level in relation to the strike prices of the long and short options. If the stock price is midway between the strike prices, the effect can be minimal.
If the stock price is closer to the lower strike price of the long put, losses generally increase at a faster rate as time passes. Alternatively, if the underlying stock price is closer to the higher strike price of the written call, profits generally increase at a faster rate as time passes.
Alternatives Before Expiration?
The combination may be closed out as a unit just as it was established as a unit. To do this, the investor enters a combination order to buy a call with the same contract and sell a put with the same contract terms, paying a net debit or receiving a net cash credit as determined by current option prices in the marketplace.
Alternatives At Expiration?
If the underlying stock price is between the put and call strike prices when the options expire, the options will generally expire with no value. The investor will retain ownership of the underlying shares and can either sell them or hedge them again with new option contracts.
If the stock price is below the put’s strike price as the options expire, the put will be in-the-money and have value. The investor can elect to either sell the put before the close of the market on the option’s last trading day and receive cash, or exercise the put and sell the underlying shares at the put’s strike price.
Alternatively, if the stock price is above the call’s strike price as the options expire, the short call will be in-the-money and the investor can expect assignment to sell the underlying shares at the strike price. Or, if retaining ownership of the shares is now desired, the investor can close out the short call position by purchasing a call with the same contract terms before the close of trading.
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