FINRA Series 7Investment Information and Suitable RecommendationsHard
A client has a substantial portfolio of highly appreciated growth stocks and is concerned about protecting their principal while still participating in market upside. They are also looking to generate a steady income stream. Which of the following option strategies would be MOST suitable for this client?
- AShort Strangle
- BCollar
- CLong Straddle
- DRatio Write
Show answer & explanationAnswer & explanation
Correct answer: B. Collar
A collar strategy involves owning the underlying stock, buying a protective put (to protect against downside), and selling an out-of-the-money call (to generate income and partially offset the cost of the put). This strategy aligns with the client's goals of protecting principal, generating income, and allowing for some upside participation up to the call's strike price.
Why the other options are wrong
- A. A short strangle is a neutral/income strategy, but involves selling both a put and a call, exposing the client to significant downside risk.
- C. A long straddle is a volatility strategy, not focused on principal protection or income generation on an existing stock portfolio.
- D. A ratio write involves selling more calls than owned stock, exposing the client to unlimited risk if the stock rises significantly.
Collar Strategy
A collar strategy is an options strategy used by investors who own an underlying stock to protect against a significant decline in its price while also generating income. It involves buying a protective put and simultaneously selling an out-of-the-money call.
- Components: Long Stock + Long Put + Short Call.
- Protects against downside (via long put).
- Generates income (via short call).
- Limits upside potential to the call's strike price.
- Often used by investors with large, appreciated stock positions.
Memory trick: Protect with put, Pay with call, Collar your stock.