Options: A Collar Play in Prudential

The Feb 25 puts have traded over 6,000 times today vs. open interest of 400. The Feb 35 calls also have traded more than 6,000 times vs. an open interest of roughly 750.
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By Jud Pyle, chief investment strategist for the Options News Network

Shares of

Prudential Financial

(PRU) - Get Report

were down nearly 4% at one point today to $31.50. But considering that shares of PRU spent most of November below $30, this is a slight pullback. In fact, on Nov. 20, PRU bottomed at $13.73, meaning that even with today's pullback, the shares are up more than 120% from their lows. One option investor made trades today to position for limited upside in PRU.

The Feb 25 puts have traded over 6,000 times today vs. open interest of 400. The Feb 35 calls also have traded more than 6,000 times vs. an open interest of roughly 750. What was happening here is the customer was buying the put and selling the call. This strategy is typically referred to as a collar.

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In this instance, the customer sold the Feb 35 calls for around $3 and bought the Feb 25 puts for around $1.90. So all together they were collecting about $1.10 for the spread. The reason that this strategy is called a collar is because if the investor is long stock, he has effectively "collared" his returns. If the stock goes below 25 at expiration, the puts kick in and the customer does not lose any more money. In exchange for that protection, the customer has sold off the upside in the form of the 35 calls. If the stock is above 35 at expiration, the investor will be called away on their shares, thus capping their gain.

This collar trade also gives us a chance to look at something called skew. It's a term that option traders use to describe the difference in implied volatilities from one strike to the next in the same expiration month. For example, in this trade, the price of $1.90 in the Feb 25 puts translates to an implied volatility of roughly 120 with the stock at $31.90, while the price of $35 in the Feb 35 calls translates to an implied volatility of closer to 95.

A collar trade like this does not mean that investors should run right out and sell their shares. But it is a good exercise to at least pay attention to how far the shares have come and how fast. It also gives insight into what kind of implied volatility differences at least one investor is willing to pay for downside protection.

Jud Pyle is the chief investment strategist for Options News Network and the portfolio manager of TheStreet.com Options Alerts. Click here for a free trial for Options Alerts. Mr. Pyle writes regularly about options investing for TheStreet.com.

Jud Pyle, CFA, is the chief investment strategist for Options News Network. Pyle started his career in finance in 1994 as a derivative analyst with SBC Warburg. After four years with Warburg, Pyle joined PEAK6 Investments, L.P., in 1998 as an equity options trader and as chief risk officer. A native of Minneapolis, Pyle received his bachelor's degree in economics and history from Colgate University in 1994. As a trader, Pyle traded on average over 5,000 contracts per day, and over 1.2 million contracts per year. He also built the stock group for all PEAK6 Investments, L.P. hedging, which currently trades on average over 5 million shares per day, and over 1 billion shares per year. Further, from 2004-06, he managed the trading and risk management for PEAK6 Investments L.P.'s lead market-maker operation on the former PCX exchange, which traded more than 10,000 contracts per day. Pyle is the "Mad About Options" resident expert. He is also a regular contributor to "Options Physics."