Take the Money, Don't Tell the IRS ... Yet
What It Looks LikeHere's an example. Suppose we own 100 shares of Forest Laboratories ( FRX) and have enjoyed a nice 55% gain over the past 12 months. On Dec. 3, with the shares trading at $108.50, you could buy a January 105 put for $3.80 and sell a January 110 call at $4.50 for a net credit of $70 (each option controls 100 shares, so 70 cents x 100 = $70). Remember, the purchase of the put gives you the right to the stock should it fall below $105; the short call obligates you to sell the shares should they rise above $110. Essentially, the sale of the call is financing the purchase of the put. The stock is now collared between $110.70 (the call strike plus net credit) and $105.70 (the put strike plus net credit). At the current price of $108.50, the maximum gain is $220, or 2.1%, and the maximum loss is $280, or 2.6%.
|Using the Collar |
Some possible end results
|Option||Credit/Debit||Break Even||Net Break Even||Average Sale Price|
|January 105 Put||($380)||$101.20||$105.70||$103.45|
|January 110 Call||$450||$114.50||$110.70||$112.60|
The table above shows an average sale price of $108.03. The loss of 47 cents, or 0.04%, from the current price of $108.50 represents the risk/reward ratio of this particular collar in which the maximum gain is $220, while the maximum loss is $280 per 100 shares. The table below spells out the profit and loss profile relative to a move in the underlying stock price from $108.50 a share.
|Profit and Loss Profile |
What happens with stock movement?
|FRX Stock Price||Long 100 Shrs P/L||105 Put P/L||110 Call P/L||Net Profit/Loss|
As the names suggest, this strategy is designed to lock in a price range in which one would be willing to sell shares. In the example above, a sale of Forest Labs at $110 will be triggered by the short calls, and a sale no lower than $105 is protected by the long put. In neither case will the actual sale of the underlying stock occur before the end of the year. By identifying stocks that have recorded substantial gains this year and using a collar to lock in gains, one can defer taxes, making 2002 a bit easier to swallow. If, on the Jan. 18 expiration day, Forest Labs is trading between $105 and $110, both the put and call will expire worthless. You will continue to be long the stock, and you'll have collected $70 in net premium.