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Article By: JamesJ.Dehoiver
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The Collar Strategy Can Protect Your Stocks Using Put Options
The average stock trader will simply buy stocks based on some selection criteria, and then for the most part, will simply hope for the best that the stock will go up in value, and in a bull market there's a good chance that will happen.
Statistics show that in a bull market about 75% of the stocks will follow the general trend and go up, and in a bear market 75% will also go down. Trading with the trend is the best way to trade as 9 out of 12 stocks will follow the trend and give you the best chance of making gains on your stock purchases.
But what if you own some good stocks and don't want to sell when the market is clearly going down, or about to go down?. There are a couple of tactics that you can consider, both of which involve the use of options, CALL options and PUT options. There is the widely known strategy called Covered Calls, and the much lesser known one called the Married Put.
Option trading can be very confusing and difficult at 1st, actually it's not that complicated once you have had a good education in the subject. However if terms like Put and Call Option, Married Put and Covered Call don't mean anything to you, don't attempt to trade options until you get that essential education in the theory.
Selling calls against your stock in 100 share increments is the basis of the covered call strategy and it can provide about a 2-7% buffer against the loss in stock price. However a bigger drop in stock price will not be compensated for using the covered call strategy, in general.
The big problem with the covered call strategy is that it only provides very limited downside protection and if the stock takes a big cut like 25%, which can happen, you lose big time and only recover about 3-5% of the loss.
The Married Put is the prefered way of protecting stocks, over the covered call, this is because it offers much larger protection. As the stock goes down, the Put will gain rapidly in value depending on it's delta value and strike price, these have to be selected carefully to match the stock, hence the term married Put.
There are a number of parameters that need to be considered when creating a Married Put for protection, the following list highlights the main points:
1. The PUT strike price
2. The current stock price
3. Choice of options, in or out of the money
4. How much option time you want to buy
The last point is very important because the Put options that you buy only have a limited life and you need to consider for how long you need the protection. The big advantage of the Married Put strategy over the Covered Call strategy is that if selected correctly it can provide 90-95% loss protection in the event of a large drop in the stock price.
The disadvantage of the Married Put strategy is that you have to buy the Put option, i.e. it costs you money, whereas the covered call is a net credit, whoever said option trading was easy?. Having said that I have not yet told you the full story of the Married Put, there's much more. There are ways of off setting the cost of the Put so that this strategy becomes self financing and can make heaps of money when the market is very volatile.
The general idea of the Collar Trade is to combine the covered call and married Put strategy into one, this is what is called the Collar Trade. In effect you put a collar around the stock, sell a call and buy a PUT. If you do this correctly most of the cost of the Put can be offset by the credit from the covered call so you can protect your valuable stock at almost no cost. Yes this is a great strategy which the general public is unfortunately very ignorant of, and most brokers don't understand.
Article Source: ArticleZones.com
About the Author
James J. Dehoiver is an experianced options trader, he also loves to learn stock trading systems and master the best technical indicators for stock investors.
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