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Investing Specialists

Grab Your Profits by the Collar

Collars can reduce the cost of insuring your stocks from a market downdraft.

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In last week's article, I talked about protecting what you've got--"hedging" in the parlance of professional investors. The problem with hedging, you might remember, was that it was so terribly expensive. For example, just today, I replied to an OptionInvestor subscriber who wrote in asking about hedging the shares of semiconductor equipment manufacturer  Applied Materials (AMAT).

It turns out that the cost of a put option to hedge his financial exposure to Applied Materials would have been about 9.2% of the shares' market value for protection that expired in October. That percentage may not sound bad, but framing this in terms of home insurance, it would be like paying $46,000 in premium every six months to insure a $500,000 home.

But do not despair! For those of you who want some downside protection, there are a few option strategies one can use that are easier on the pocketbook. Today, we will discuss one: the collar.

Erik Kobayashi-Solomon does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.