By Adam Warner of OptionsZone

Volatility is back on the high end of normal again, and there's nothing wrong with paying up for options, especially when the market has broken perceived support. But you're understandably squeamish. By the same token, the CBOE Volatility Index ( VIX)(VIX) is in the mid-30s, not the mid-60s, so selling options into this is far from a no-brainer.

You might be considering iron condors here, as they are a decent way to sell some options. But if you started as recently as yesterday even, you're likely already long from the put spread side.

So what about collars? In my opinion, this is a good strategy to use now, especially with some tweaks.

A collar refers to a combination of owning the stock, and then buying out-of-the-money (OTM) puts against it by "funding" them with OTM call sales.

For example, let's say you bought 100 shares of Potash Corporation of Saskatchewan ( POT) POTat $88 (now trading for $85). To slap on a classic collar, you buy one July 80 put, now at $1.35, and then fund it by selling a July 90 call, now trading the same price.

The end result is a position identical to simply owning the July 80-90 bull call spread. The cost is essentially $5, which is your maximum loss if POT expires under $80 (and you do nothing). Your maximum gain is $10 minus the $5 you paid, or $5, and you realize that gain if you do nothing and POT closes at or above $90.

That's all well and good if you want a bullish play on POT. But let's say you're more interested in a volatility play. Say you think POT will either crash or the selling will abate and the stock will grind back up a bit. In that case, how about a "ratio collar"?

Let's say you purchase 10 of the puts, short 10 of the calls, and hedge it "neutral" by purchasing 500 shares. I realize this is a big capital usage difference from the above, but options only trade in ones, so consider this for illustration purposes.

What does this spread do for you? Well, for starters, you now own some options gamma on the downside. You own 500 shares, and 10 puts, so that's 500 extra shares you can buy at some juncture. And if POT declines, the calls you sold will not come into play. So your effective cost of the puts is zero.

The best-case scenario is if you wake up one day and POT has gapped down huge. The second best case is that the sell-off has abated, and POT starts to nudge higher. If it gets near $90 and time starts to dwindle as expiration approaches, you do quite well, too. You scratch on the put/call combo, and win on the 500 shares of stock you own to more than offset it.

Sounds great right?

Well, there's also a risk side to every trade. One risk here is that POT goes to $90 or higher very quickly. You own 500 shares, but you're also short 10 calls, so that's unlimited exposure on the short calls.

The other risk is a slow drift to $80, though that's a defined risk. And remember you effectively didn't pay anything for the puts, and likely had opportunity to buy and flip stock on the way down. Not to mention that POT declining further would likely be accompanied by increasing volatility. So I'd take my chances with that.

I do not have a position in POT, and use this example for educational purposes. But I do like this strategy, and it can be used successfully in this market.

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