Collars (short)

Short collars are slightly more complicated for the average investor to understand as most of the position is short.  Although not necessarily a neutral strategy, the investor is neutral to slightly bearish in outlook.  The attractive feature of the short collar is the risk minimization, while still allowing for attractive return potential.  The short collar involves a short stock position in conjunction with a short Put and long Call.  The trade has limited risk and limited return potential.  Let's examine a trade.

An investor feels that BVF has limited upside potential, and more likely the stock may be susceptible to a moderate decline.  The investor decides to arrange for a short sale of 1000 shares of BVF, at the current price of $20.  Although the investor is bearish, they are still not willing to have unlimited risk should the stock rise.  The investor decides to protect their short by buying 10 mid-term BVF $20 Calls @ $1.75.  The investor pays $1,750.00 for that protection.  To help offset this debit, the investor decides to short 10 mid-term BVF mid-term $15 Puts @ $0.75.  The investor receives $750.00 in option premium.  The net cost of the option trades is $1000.  The investor has maximum risk of the net debit for the options, in this case $1,000.00.  The investor has maximum return potential of $5,000.00 (short sale entry of $20, less strike on short put of $15, equals $5 gross return potential), less the option premium paid of $1,000.00 equals a total net return potential of $4,000.00 on this entire trade.  The investor will achieve the maximum return if at expiration BVF is trading at or below $15.  The investor's breakeven is at $19 (short sale price of $20 less option premium paid of $1, equals breakeven of $19).  Attractive return potential with known downside risk.