While I am a huge fan of using option collars around my stock positions, my real preference is to create what I call “dog collars.” That’s where the stock I collar is one that is, shall we say, down on its luck. An equity market “dog.”

My goal with these trades is to position for a high-octane comeback story while simultaneously managing my risks. That allows me to have the courage to take a much larger position than I normally would. Because I am, after all, a “chicken” when it comes to investing. I have that habit to thank for surviving decades as a professional investor.

But just because I prefer to collar dogs, does not mean you need to. 

So, to prove this setup works for stocks hot – or not – here is a collar structure I identified on a stock that is more of a lion than a lamb.

Palantir: How to Collar a Red-Hot Stock 

The stock is Palantir (PLTR), which is a leading provider of technology to the defense sector. All PLTR has done since the start of 2023 is rally… from about $6 a share to $144 as of Thursday’s close. Even those who are great at math might need a calculator before marveling at the 2,300% return on this stock in just 2.5 years. But doesn’t that make it expensive?

Gee, I don’t know. Is a trailing price-earnings ratio of nearly 1,200x expensive? How about a stock selling at more than 60x book value? 

PLTR boasts a rabid following, so apparently its valuation has not caught up to it. 

The stock has a 2.6 beta as well. That means it has been more than twice as volatile as the broader stock market. And it proved to be vulnerable to market-wide declines, such as earlier this year when it dropped nearly 50% in just a matter of weeks. 

Still, super stocks like PLTR rise in price until they don’t. That obvious statement doesn’t help you much, but maybe this will: 

You can take your best shot at riding the rocket ship that is PLTR higher, but decide the moment you buy it how much you are willing to risk. 

OK, Just Show Me the Trades!

I’ll show you two. The first is shorter term and the other uses a much longer time frame. My goal here is not only to remind you of the simple elegance of collaring stocks, but to use this pair of examples to better understand how this whole thing works. A 1-year price chart of PLTR is shown here. 

My collar work is based heavily on my assessment of the chart. However, that usually involves trying to gauge upside potential and downside risk of “normal” stocks that perhaps appear to be reversing a decline. 

In the case of PLTR, it has been “number go up” for so long, it is literally in uncharted territory. So, I’ll focus less on the technicals, and more on using the collar structure to show how I’d seek to manage risk while still having exposure to as much “juice” as this stock might continue to offer.

Trade #1: Short Term

Using Barchart’s option tool and selecting “Protection Strategies” and then “Protective Collar,” this came right up for me, among dozens of other potential combinations. I chose this setup, which has a more than 3:1 best case to worst case outcome. Over just the next 3 months, I can shoot for up to 21.5% upside in the stock, with a maximum loss of 6.3%. 

Is there a catch? Note the “BE” column, which stands for break even. 

As shown in the next column to the right, the net cost per share of the call options struck at $190 and the put options struck at $150 is nearly $15 a share. PLTR traded around $144 at the time, so I’ve paid $15 to have the right to sell the stock $6 higher. So $9 a share is my risk here, while $31 a share is my maximum upside before the risk of getting the stock called away from me. 

As you may know from reading my work here, I am happy to have such a high-class problem, a stock up 21% in 3 months or less. Even for a powerhouse past performer like PLTR. 

Still, that option cost is a hurdle. Another way to think of it is that the first $15 of appreciation in PLTR over the next 3 months simply earns me back the cost of the options. Again, this is just to help you understand the math. There are many different versions of the trade that allow an investor to decide what levers they wish to pull.

Trade #2: Long Term

Here, I went out a lot further in time (more than 18 months instead of only 3), but kept the strike prices the same. The call-put range is $190 to $150.

Here come those tradeoffs. Look at the bid price of the call and ask price of the put, which is the best estimate of what the prices might be if I put in a market order for both sides of the collar. 

In round numbers, they are $32 received in cash for the covered calls, and $42 paid out for the protective puts. The same strike prices in the first collar example have option premiums of $5 and $20 respectively. So while the put cost doubled to pay for all of that extra insurance time, the calls are more than 6 times higher. That results in a slightly higher upside cap of 24.5%, and a downside cap that is about half that of the first example, around 3.2%. So, the up/down ratio went from 4:1 to nearly 8:1. However, the annualized return is a lot less, given the 18 months to expiration here, versus only 3 months in the earlier case.

The Bottom Line: Collars Can Be Your Pal, Even With Stocks Like Palantir

This is just lifting the lid of Pandora’s box that is options pricing. But more importantly, the emphasis here is on those tradeoffs. Remember that this is a stock that has had the type of up move that is more likely to spike further or collapse suddenly than hang out around its current $144 price level. 

That’s something to consider.