Collar

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A Collar is an options trading strategy that is constructed by holding shares of the underlying stock while simultaneously buying Protective Puts and selling call options against that holding. The puts and the calls are both out-of-the-money options having the same expiration month and must be equal in number of contracts.

Technically, the Collar strategy is the equivalent of a out-of-the-money Covered Call strategy with the purchase of an additional Protective Put.

The Collar is a good strategy to use if the options trader is writing Covered Calls to earn premiums but wish to protect himself from an unexpected sharp drop in the price of the underlying security.

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Limited Profit Potential

Limited Risk

Breakeven Point(s)

Example

Suppose an options trader is holding 100 shares of the stock XYZ currently trading at $48 in June. He decides to establish a Collar by writing a JUL 50 Covered Call for $2 while simultaneously purchases a JUL 45 put for $1.

Since he pays $4800 for the 100 shares of XYZ, another $100 for the put but receives $200 for selling the call option, his total investment is $4700.

On expiration date, the stock had rallied by 5 points to $53. Since the striking price of $50 for the call option is lower than the trading price of the stock, the call is assigned and the trader sells the shares for $5000, resulting in a $300 profit ($5000 minus $4700 original investment).

However, what happens if the stock price goes down 5 points to $43 instead? Let's take a look.

At $43, the call writer would have had incurred a paper loss of $500 for holding the 100 shares of XYZ but because of the JUL 45 Protective Put, he is able to sell his shares for $4500 instead of $4300. Thus, his net loss is limited to only $200 ($4500 minus $4700 original investment).

Had the stock price remained stable at $48 at expiration, he will still net a paper gain of $100 since he only paid a total of $4700 to acquire $4800 worth of stock.

These examples use standard U.S. stock options with a 100-share contract size and matching expiration dates. Related structures can use ETF, index or futures options, but contract multipliers, exercise style, settlement and the underlying price range can differ. A stock’s zero price floor must not be assumed for every futures contract.

Commissions

For ease of understanding, these examples exclude commissions, fees and financing costs. Include all costs when comparing an actual position; there is no universal commission amount.

For active traders, transaction costs can consume a significant part of returns. Compare the full commission and fee schedule, exercise and assignment charges, and bid-ask spreads. The cost of entering and closing every leg matters.

Summary

The beauty of using a Collar strategy is that you know, right from the start, the potential losses and gains on a trade. While your returns are likely to be somewhat muted in an explosive bull market due to selling the call, on the flip side, should the stock heads south, you'll have the comfort of knowing you're protected.

Similar Strategies

The following strategies offer related market exposure. Compare their construction, cost, maximum loss and assignment obligations; a similar outlook does not mean identical risk.

Costless Collar (Zero-Cost Collar)

Bull Put Spread

Bull Call Spread

The Costless Collar

If capital protection rather than premium collection is the main focus, a bullish investor can establish an alternative Collar strategy known as the Costless Collar.

Before expiration and assignment

The diagrams and worked outcomes describe expiration payoffs, not an option’s market price before expiration. Time decay, implied volatility, rates, dividends and bid-ask spreads affect early closing values. American-style short options can be assigned early; a protective long option is not automatically exercised when a short leg is assigned. Closing or exercising one leg can change the remaining position’s risk.