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How a Collar Works

Investors who want to continue holding an appreciated stock and protect their profits at a relatively low cost can set up a collar. They do this by buying a put option, which gives them the right to sell their stock at a certain price, and--to pay for the put--selling a call option, which gives someone else the right to purchase the stock at a specific price. Here's how a collar works on 100 shares of IBM worth $103.75 apiece.

-- You buy a put with a strike price of 95 for $530 ($500 plus a $30 commission).

-- You sell a call with a strike price of 115 for $482.50 ($512.50 minus $30 commission).

-- The total cost of the collar, which expires in April, 1998, is $47.50 (the difference between the put's cost and the call's sale price).

-- If the stock price climbs above 115, you're obligated to sell the stock at 115. So your gain is limited to the difference between your original purchase price and 115.

-- If the stock stays between 95 and 115, the collar expires worthless and you continue to own the stock.

-- If the stock drops below 95, you have the right to sell it at 95 no matter how far down it goes. Or you can keep the stock and sell the put at a profit, because now the buyer owns a put that allows him to sell it at greater than today's value.


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Updated Nov. 20, 1997 by bwwebmaster
Copyright 1997, Bloomberg L.P.
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