FINRA Series 7Investment Information and Suitable RecommendationsHard
A client, aged 60, has a substantial portfolio of highly appreciated growth stocks and is concerned about protecting their gains while still participating in some upside potential. They also wish to generate some income. Which options strategy would be most appropriate?
- ALong Straddle
- BShort Call
- CProtective Put
- DCollar
Show answer & explanationAnswer & explanation
Correct answer: D. Collar
A collar strategy is ideal for investors with a long stock position who want to protect against a decline (using a purchased put) and generate income (using a sold call), while giving up some upside potential. It's often used on appreciated stock to limit downside risk without selling the shares.
Why the other options are wrong
- A. A long straddle is a volatility strategy, not focused on protecting existing gains or generating income.
- B. A short call against a long stock position (covered call) generates income and offers some protection but doesn't provide a defined floor for maximum loss like a put does.
- C. A protective put protects against downside but does not generate income and still allows for full upside participation (which the client is willing to limit).
Collar Strategy
A collar is an options strategy combining a long stock position with a purchased out-of-the-money (OTM) put option and a sold out-of-the-money (OTM) call option. It provides downside protection, generates income from the call premium, and limits upside potential beyond the call's strike price.
- Used on existing long stock positions.
- Consists of: Long Stock + Long Put (OTM) + Short Call (OTM).
- Benefits: Limits downside risk, generates income.
- Drawbacks: Limits upside profit potential.
- Often a zero-cost collar if put premium equals call premium.
Memory trick: Collar your stock to 'protect' and 'collect', but cap your gains.