Collars (long)

Collars on long stock position.  A combination of Calls and Puts in conjunction with a long stock position can be utilized to provide attractive upside potential, while substantially reducing, if not elimination risk altogether. 

Assume an investor own 1000 shares of BVF, purchased at it's current price of $20.  The investor decides to collar the stock with the combination of short Calls and long Puts.  The investor decides they are not willing to be susceptible to any downside risk so the investor buys 10 BVF $20 mid-term Puts @$1.50.  The cost of the Puts is $1,500.00.  To share this cost, the investor decides to sell calls against the stock position to receive premium.  The investor decides to sell 10 BVF $25 mid-term Calls @$1.00.  The investor receives $1,000.00 in option premium.  The net effect of the option trades is an outlay (debit) of $0.50 or $500.00.  The investor owns the Puts for protection with a $20 strike.  The investor has foregone upside above $25 by selling the Calls.  The risk/reward profile is attractive, with just $500 downside (net cost of the Puts), while retaining very attractive upside of $4,500.00 net ($5,000.00 gross return from $20 to $25, less net cost of Puts).   In fact, what has happened by adding the collar, the investor has slightly increase the net cost of the stock by $0.50 (net option cost), the new cost base on the stock is $20.50.  Maximum gain occurs with the stock at or above $25 at expiration.