The key to understanding the collar trade is the realization that long-term calls have more time value than comparable long-term puts. And the more distant the expiration date, the larger is this difference. An explanation of this disparity in the pricing of call and put options is given in Chapter 30, “The Put-Call Parity Relationship.” Thus, selling an out-of-the-money long-term call provides extra cash to offset the purchase price of an at-the-money put. This explains why short or intermediate-term collar trades are generally unattractive.

The maximum potential loss on a collar trade is reduced by moving the strike prices of the call and put options closer together. Unfortunately, this adjustment also reduces the maximum potential ...

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