Many investors find themselves in a pickle: They don’t want to risk any more losses, but they also don’t want to indiscriminately dump their stock holdings now, either, regardless of the 2-day rally.

If you sell a holding now, it may be psychologically difficult to reestablish the position paying higher prices. Also, wholesale liquidation could have tax consequences.

A lot of investors would like a way to put there positions on hold while they wait for the market to settle down and find firmer footing. One way you can do this is by using options to establish a collar.

A collar is a position consisting of long stock, long put and short the call. When put and call the both have the same strike price it is called a conversion. These can be done in conjunction with a new stock purchase, but the strategy is typically used to lock in a minimum sale price on an existing long-stock holding.

Because a conversion essentially locks in the stock’s current price -- meaning there's upside profit potential (and no downside risk) -- the IRS might consider it a constructive sale. Conversions therefore have tax implications; to consider these, we'll focus on creating a collar using different strike prices.

How Long a Leash?

For example, assume you own 1,000 shares, one of which is Wal-Mart (WMT) -- one of the few issues to have posted a gain over the past year -- but you worried that if the economy recovers, consumers will stop trading down and start shopping at nicer stores. You want to establish a minimum sale price as you wait to see how things play out.

With Wal-Mart trading around $47.80 a share, one could establish a collar by purchasing the strategy by April, purchasing the $47.50 put for $2 a contract, and selling April $50 call for $1.30 per contract. This gives the stock an effective cost basis of $48.50 a share (the current stock price, plus the purchase price of the put, minus sale price of the call).

Meaning the minimum sale price of $47.50, if you exercise the put option, would result in a $1, or 2% loss, from current price.

The maximum sale price is of $50 if the call assigned would provide $1.50, or 3.1% gain, from the current price.

This collar creates a position in which the profit potential is 50% greater than the maximum loss.

Your market view and timing considerations will help determine which strikes and expirations to use. For instance, if you just need to ride out a few turbulent weeks or an upcoming event -- such as an earnings report, or a court or regulatory ruling -- then using short-dated options make sense.

If, on the other hand, you're still fundamentally bullish on your holding, you might want to use longer-dated options with wider strike prices that will allow for more potential upside. But be aware: That will also expose you to more risk.

Collars are a great solution to help steady your portfolio during uncertain times, or to simply lock in a range in which you'd be happy to sell the shares.

But note that this comfort also comes with some opportunity cost. The money (margin or otherwise) needed to maintain the collar position is essentially dead money, whereas the proceeds of a sale of the long stock could be reinvested - even if it's at the current paltry money-market rates.

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