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How to Select the Best Strike Prices for Collar Trades: Real-Life Example with Advanced Micro Devices, Inc. (NASDAQ: AMD) – March 1, 2021

Covered call writing is associated with 2 legs: we are long the stock and short the call option. If we add a protective put, we have converted the covered call trade to a collar trade which has both a floor (put strike) and a ceiling (call strike). The traditional collar trades uses out-of-the-money strikes for both option positions. This article will simplify the process for determining which are the most appropriate strike prices to choose.

Setting our initial time-value return goal range for collar trades

Since we are incurring a debit when we buy the protective put, we must select a lower range than we would for traditional covered call writing. The higher the returns, the greater the risk so we must find a range that aligns with our personal risk-tolerance. This will vary from investor-to-investor. For me, it’s 2% – 4% and up to 6% in bull markets for 1-month near-the-money call options. For collars, we would adjust that range depending on how much protection we are seeking. A reasonable range for collars for those seeking returns similar to mine would be 1% – 2% per month and up to 3% in bull markets (in strong bull markets, we may opt not to buy protective puts).

• The $79.00 call generated $4.00 per-share
• The $70.00 put costs $1.84 per-share

Collar Calculations with the BCI Collar Calculator

Initial time-value results

• The net 1-month time-value return is 2.79%
• Maximum 1-month return with upside potential is 4.82%
• The maximum 1-month loss is 6.81%

Discussion

Collar strikes are generally out-of-the-money. We first set the initial time-value return goal range that fits our personal risk-tolerance profile for the call premium and then halve that amount to buy the protective put. The option-chain will guide us to those appropriate strike selections.

Author: Alan Ellman