How to Use a 'Collar' to Protect Stock Gains: A Tesla Case Study

Summary

The article discusses how long-term investors can protect their stock gains amidst market volatility, using Tesla as a case study. It introduces the concept of a 'collar' strategy, which allows investors to manage risk without selling their core holdings. A collar defines a temporary downside floor and an upside ceiling, providing clarity and structure during uncertain market conditions.

Understanding the Collar Strategy

A collar consists of three main components:

• Owning the shares of the stock.
• Buying a put option to sell shares at a specific price.
• Selling a call option to give someone else the right to buy shares at a specific price.

The put option acts as insurance, allowing the investor to sell shares at a predetermined price, while the call option generates income to help finance the put. This strategy creates boundaries around the stock position, limiting potential losses and gains.

Building the Collar

Step 1: Set the Calendar

Investors must first determine how long they want protection. This could align with events like earnings releases or periods of market uncertainty.

Step 2: Set the Floor

Next, investors decide how much downside risk they are willing to tolerate. The put option defines the floor, limiting losses to a certain level.

Step 3: Set the Ceiling

Finally, investors choose how to finance the protection through the call option, which determines the upside cap in exchange for the downside protection.

Applying the Collar to Tesla

For an investor who bought Tesla shares at around $410, the collar strategy can be applied as follows:

• Calendar: Selected expiry date is April 17, 2026, providing a two-month protection window.
• Floor: A put option with a strike price of $385 is chosen, allowing for some fluctuations while protecting against significant losses.
• Ceiling: A call option with a strike price of $440 is sold, capping potential gains but generating income to offset the cost of the put.

This structure creates a defined range for the stock price, limiting losses below $385 and gains above $440.

Living with the Collar

Once the collar is active, the investor monitors the stock's performance within the defined boundaries. The article outlines three potential scenarios:

• Scenario 1: If Tesla rallies above $440, shares may be called away, achieving the predefined return.
• Scenario 2: If Tesla declines below $385, the put option gains value, preserving capital during the downturn.
• Scenario 3: If Tesla trades between $385 and $440, both options lose time value, and the investor prepares for expiry.

Final Thoughts

The collar strategy does not predict market direction but instead defines boundaries for stock performance. It answers key questions about the duration of protection, acceptable downside, and the trade-off for upside potential. This approach provides a structured way for investors to manage risk while remaining invested in their core holdings.