- 1). Apply for option trading authorization in your stock brokerage account. Stock brokers require a completed Options Agreement before options trading is allowed in an account. Your account should have at least level 2 option trading authorization.
- 2). Look up the option chain for the stock you want to collar. The option chain can be located by looking up the stock price using your broker's quote screen and there will be a link for the option chain next to the price quote. A link to the option chain may also be available from your account summary screen. An option chain is a listing of the different options available for a specific stock and the prices for each option.
- 3). Determine how long you want the collar to last and select the option chain with an expiration in the months nearest that. Options are usually available for the current and next month, then in 3 month increments out to six or seven months. The collar protects against falling share prices but also limits the upside potential of the share value.
- 4). Look up the price of a put option with a strike price below the current share price and a call option with a strike price above the current share price. Put options are the right to sell the underlying stock and call options are the right to buy the underlying stock. The strike price is the price at which the option holder can elect to exercise the option contract. For example, IBM is trading at $128.50 per share. The put option with an expiration in three months and a strike price of $125 is quoted at $3.50 and a call option for the same month with a strike of $130 is quoted at $3.70. An option contract costs 100 times the price quote. For example, you would pay $350 plus commissions to buy one of these put option contracts.
- 5). Establish you collar by buying put options and selling an equal number of call options to cover your stock position. The best way to place the trade is to select the specific options by clicking or checking a box next to the option and going to the options trade screen by suing the strategies menu on the screen. Your brokerage account option screens will have a menu where you can select a specific option strategy, in this case a collar, and be taken to the trade screen with the option symbols and price boxes correctly filled. You must enter the number of contracts for each side, puts and calls, and enter the trade. Each option contract is for 100 shares of the underlying stock. For example, if you own 500 shares of IBM, you buy five put contracts at a cost of $1,750 and sell five call contracts for a credit of $1,850. You receive a credit of $100 to set up this particular collar, less commissions.
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