Equity Collars Presented by The Options Industry Council "

Please note that the information provided today and the views expressed are mine and do not necessarily reflect the views of the New York Stock Exchange, its parent, subsidiaries or affiliates, or any of its officers or directors.

Equity Collars Options involve risks and are not suitable for everyone. Prior to buying or selling options, an investor must receive a copy of Characteristics and Risks of Standardized Options. Copies may be obtained by contacting your broker or The Options Industry Council at One North Wacker Drive, Chicago, IL 60606. In order to simplify the computations, commissions, fees, margin interest and taxes have not been included in the examples used in these materials. These costs will impact the outcome of all stock and options transactions and must be considered prior to entering into any transactions. Investors should consult their tax advisor about any potential tax consequences. Any strategies discussed, including examples using actual securities and price data, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation, or solicitation to buy or sell securities. Past performance is not a guarantee of future results.

Presentation Outline • Equity

Option Basics

• Collar

Basics

• Specific

Collar Example

-

stock closes below put strike

-

stock closes between call & put strikes

-

Stock closes above call strike

• Before • Rolling

Expiration

Equity Option Basics

Equity Option Basics • Equity

options are contracts

• Option

buyers get rights

-

an equity call buyer gets the right to buy… an equity put buyer gets the right to sell… 100 shares of underlying stock

• Option -

sellers get obligations

an equity call seller gets the obligation to sell… an equity put seller gets the obligation to buy… 100 shares of underlying stock

Equity Option Basics • Equity -

calls

exercise generates a stock purchase assignment generates a stock sale

• Equity -

puts

exercise generates a stock sale assignment generates a stock purchase

• Stock

sales & purchases at strike price

• Exercise -

or assignment

at any time before options expire

Equity Option Basics • Option -

exercise contract sell contract to close let expire with no value

• Option -

writer’s choices

accept assignment purchase contract to close let expire with no value

• Have -

holder’s choices

a plan in advance for any scenario

what do you do if the market goes against you?

Covered Call Basics • Write

a call covered by underlying shares owned • Receive & keep call premium -

limited downside protection

-

increased return on owned shares

• Obligation

to sell underlying shares

-

at strike price

-

if assigned at any time before expiration

• Receive

dividend unless assigned

Protective Put Basics • Buy

put to protect underlying shares

-

guaranteed selling price at strike (insurance)

-

may increase in value with declining underlying price

• Pay

put premium • If underlying stock goes down -

may exercise to sell shares

-

may sell put in marketplace to offset stock loss

• Upside -

profit potential unlimited

less cost of put

• Receive

dividend as long as stock owned

Collar Basics

What Is an Equity Collar? • Long

underlying shares • Write covered call & buy protective put -

1 call & put for each 100 shares owned

• When -

option positions established

both call & put generally out-of-the-money

• Simultaneously -

pay put & receive call premium

either net debit, net credit or no cost (even)

• Bullish

or bearish?

-

protective on downside – long put

-

moderately bullish on upside – covered call

Why Use a Collar? • Stock -

downside protection – long put some upside participation – capped by covered call

• Key -

investor with unrealized gains who wants

benefits

cost of downside protection reduced by call premium investor’s objectives met whether stock up or down if stock sits smaller net debit lost (or net credit kept) dividend received if not assigned on short call

• Drawback -

upside profit potential limited if assigned

Before You Use a Collar • What

downside protection needed?

-

select appropriate put strike price

-

consider timeframe

• Upside

participation on stock?

-

select appropriate short call strike price

-

be happy with stock sale price if assigned

• Net

stock sale price?

-

if put exercised or assigned on call

-

strike less net debit (or possibly plus net credit)

Before You Use a Collar •

•

•

Balance two factors: -

put premium paid & protection provided - risk

-

call premium received & upside potential - reward

Important: -

avoid focusing primarily on net debit/credit

-

get protection you need

-

be content with limited degree of upside participation

-

be willing to sell shares if assigned on call

The long put & taxes -

buying put may affect holding period on stock

-

obtain Taxes & Investing from 888OPTIONS.COM

Establishing Collar • One -

collar

Long 100 underlying XYZ shares Long 1 XYZ put Short 1 XYZ call

• Option -

specs

call & put generally have same expiration month put generally OTM when bought – i.e. lower strike call generally OTM when sold – i.e. higher strike

• Analyze

put/call alternatives before establishing -

Options Investigator allows testing multipart positions obtain software from OIC

Establishing Collar • Net -

• Net -

• Net -

premium possibilities at outset net debit net credit zero-cost

debit puts cost more than call premium received

credit call premium received more than cost of puts

• “Zero-cost” -

collar

call premium received = put premium paid

• Depends

entirely on strike prices chosen

Collar Example Established at Net Credit

Example • Investor -

owns 100 XYZ shares

purchased at $50 per share XYZ currently at $62

• Dividend

in 1 week – investor wants to receive • Downside protection wanted for 2 months • Investor willing to sell XYZ shares at $65 • Currently: -

60-day XYZ 60 put trading for $1.90 60-day XYZ 65 call trading for $2.00

Example • Investor -

XYZ currently at $62 60-day XYZ 60 put trading for $1.90 60-day XYZ 65 call trading for $2.00

• Buying -

owns 100 XYZ shares @ $50

1 XYZ 60 put cost $1.90 x 100 = $190

investor considers put too costly

• Selling

1 XYZ 65 call brings $2.00 x 100 =

$200 -

• Net -

premium received will more than finance put cost

result: $2.00 for call – $1.90 put cost = $0.10 credit total credit received & kept = $0.10 x 100 = $10

Example • Position: -

long 100 XYZ @ $50 – currently @ $62 long 1 XYZ 60 put & short 1 XYZ 65 call

• Net

credit received = $0.10 ($10 total) • Downside protection -

if put exercised XYZ shares sold no lower than $60 profit per share protected = $10 no net cost for insurance

• Upside -

potential

if call assigned shares sold @ $65 total profit on shares = $15 per share

XYZ Below $60 at Expiration Below Put Strike Price • XYZ

closes at $55 at expiration

-

XYZ 60 put in-the-money with $5 intrinsic value

-

XYZ 65 call out-of-the-money & with no value

• Investor’s

choices

-

exercise put & sell shares at $60 put strike price

-

retain shares & sell put to partially offset stock loss

-

roll collar to future expiration month

XYZ Below $60 at Expiration Below Put Strike Price – Sell Put • XYZ

closes at $55 at expiration

• Investor

retains shares & sells XYZ 60 put

-

receives $5 if sold for intrinsic value

-

keeps $0.10 net credit initially received

-

net cash taken in = $5.10

• Result -

retains 100 original XYZ shares

-

cost-basis reduced: $50 original cost - $5.10 = $44.90

-

unrealized profit on position at expiration = $10.10

XYZ Below $60 at Expiration Below Put Strike Price – Sell Put 100 XYZ purchased at $50 XYZ at Expiration

Sell 60 Put (intrinsic)

Net Credit Received

Reduced XYZ Cost Basis

60 55 50

0 5 10

.10 .10 .10

49.90 44.90 39.90

45

15

.10

34.90

40

20

.10

29.90

XYZ Below $60 at Expiration Below Put Strike Price – Exercise Put XYZ closes at $55 at expiration • Investor exercises XYZ 60 put & sells shares • Net sale price for XYZ shares •

-

•

$60 put strike + $0.10 collar credit received = $60.10

Result -

XYZ shares purchased @ $50 sold at $60.10 investor's downside objective met (sell at $60) realized profit on 100 XYZ shares = $10.10 $60.10 = sale price ($10.10 profit) if put exercised no matter how low XYZ declines

XYZ Between $60 & $65 at Expiration Between Strike Prices • Both -

60 put & 65 call expire out-of-the-money

collar expires with no value

• Investor -

or loses net debit if paid for collar initially

• Investor -

retains shares

has unrealized profits over $50 purchase price

• Investor -

keeps $0.10 credit received for collar

can establish another collar

expiration & strike prices of choice

XYZ Above $65 at Expiration Above Call Strike Price • XYZ

closes at $68 at expiration

-

XYZ 60 put out-of-the-money with no value

-

XYZ 65 call in-the-money & assignment expected

• Investor’s -

• If

obligation

accept assignment & sell shares at $65 call strike

assignment not acceptable -

buy (close out) 65 call at loss against share profit

-

establish new collar with expiration & strikes of choice

XYZ Above $65 at Expiration Above Call Strike Price • XYZ closes at $68 at • Investor assigned on

expiration XYZ 65 call & sells

shares • Net sale price for XYZ shares -

$65 call strike + $0.10 collar credit received = $65.10

• Result -

XYZ shares purchased @ $50 sold at $65.10 investor's upside objective met (sell at $65) realized profit on 100 XYZ shares = $15.10 $65.10 = capped sale price ($15.10 profit) if assigned no matter how high XYZ increases

Before Expiration

Before Expiration Investor’s choices • Close -

against discipline but it happens investor left with protective put

• Sell -

out call if assignment not acceptable

put if downside protection not wanted

outlooks on underlying do change investor left with covered call

• Exercise -

in-the-money put & sell shares

investor left with naked short call NOTE: sizeable margin possible

• Roll

entire collar to month & strikes of choice

Rolling

Rolling • Close -

sell put and buy call – close out existing collar buy new put & sell new call – create new collar

• May -

-

be executed as two spread transactions

closing out existing collar is one spread transaction establishing new collar is another spread transaction

• Cost -

out collar & establishing another

of rolling?

close existing collar at net debit or credit establish new collar at net debit or credit net the two debit/credits debits vs. credits depends on strikes relative to current stock price

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