Part 2: How The Collar Strategy Works In Different Scenarios For Commodities Options

Looking at the collar in the “stagnant” scenario, the commodities options price would be unchanged thus neutral in terms of return. Therefore, the potential profit or loss would come strictly from the debit or credit of the two options.

If the commodities options do not move, as in our example, both the put and call would finish out-of-the-money and be worthless.

Our profit or loss would simply be calculated from whether you paid for the collar or collected from the collar and how much that amount was.

Using the same prices as the previous example (the commodities options purchase price of $28.00, the Dec. 27.5 put $1.00 and the Dec 30 call $1.00) we will now take a look at the “down” scenario. Let’s set the commodities options price at $28.00 on expiration. At this price both the Dec. 27.5 put and the Dec. 30 call are out-of-the money and worthless. Since there is no credit or debit incurred in the option position ($1.00 inflow from the calls, $1.00 outflow from puts) the total return of the position is simply the gain or loss from the commodities options.

With the commodities options purchase price of $28.50 and a commodities options price of $28.00 on expiration, there will be a $ .50 loss in the position. Setting the commodities options price at $27.50, we see that the Dec. 27.50 puts and the Dec. 30 calls are again worthless and with no debit or credit incurred, the positions profit or loss will come down to the gain or loss on the commodities options.

With the purchase price of the commodities options being $28.50 and the commodities options price at expiration $27.50, there will be a $1.00 loss. In this case, we have reached the maximum loss. No matter how low the commodities options go, you can only incur a maximum loss of $1.00.

Now, let’s set the commodities options price at $26.00 and see if this holds true. With the commodities options at $26.00 on expiration, the Dec. 30 calls are out-of-the-money and worthless. The Dec. 27.5 puts, however, are in-the-money and now worth $1.50.

The commodities options you purchased for $28.50 is now worth $26.00 on expiration which is a $2.50 loss. Combining the $2.50 stock loss with the $1.50 gain in the puts and you have a $1.00 loss in the overall position.

This demonstrates that $1.00 is the maximum loss of the position. Keep in mind that if the commodities options position creates a debit or a credit, it must be added to, or subtracted from the stock loss.

Most of the time, there will be a small debit or credit incurred in the option position. It is relatively infrequent that the put and call used in the collar are trading at the exact same price.