Definition
A collar is an options strategy that protects a long stock position by simultaneously buying a put option (the downside hedge) and selling a call option (the upside cap). A put option gives the holder the right to sell the stock at a specified strike price; a call option gives the buyer the right to buy the stock at a specified strike price. Collars are typically structured so both options share the same expiration date.
Why use a collar
– To limit downside risk on a stock you already own.
– To offset or eliminate the cost of protection by taking on a capped upside.
– Useful when you are mildly bullish or neutral about a stock’s short-term outlook but want to preserve gains.
Basic mechanics (protective collar)
1. Own shares of the underlying stock.
2. Buy one put option per 100 shares at a chosen put strike (establishes a floor).
3. Sell one call option per 100 shares at a higher call strike (generates premium income and sets a maximum sell price).
4. Typically choose the same expiration for both options.
Key formulas (per share)
– Net premium (credit positive if call premium > put premium):
net_premium = call_premium_received − put_premium_paid
– Break-even stock price at expiration:
break_even = stock_purchase_price + put_premium_paid − call_premium_received
= stock_purchase_price − net_premium
– Maximum profit (if stock is at or above call strike at expiration):
max_profit = (call_strike − stock_purchase_price) + net_premium
– Maximum loss (if stock is at or below put strike at expiration):
max_loss = (put_strike − stock_purchase_price) + net_premium
Note: max_profit and max_loss are per share; multiply by number of shares (usually 100 per option contract).
Worked numeric example
Assumptions:
– You own 100 shares of ABC purchased at $80.00 per share.
– Current stock price: $87.00.
– Buy 1 put with strike = $77, premium paid = $3.00.
– Sell 1 call with strike = $97, premium received = $4.50.
Calculations:
– Net premium = 4.50 − 3.00 = +$1.50 per share → you receive $150 total.
– Break-even = 80 + 3.00 − 4.50 = $78.50 per share.
– Maximum profit per share = (97 − 80) + 1.50 = $18.50 → $1,850 total.
– Maximum loss per share = (77 − 80) + 1.50 = −$1.50 → loss of $150 total.
Interpretation:
– If ABC rises above $97 by expiration, your stock will likely be called away at $97; your total gain is capped at $1,850.
– If ABC falls below $77, the put limits your downside so your worst total loss on the position is $150 (because the put lets you sell at $77 and you received $1.50 premium net).
– If ABC finishes between $77 and $97, your P&L equals the stock move plus the net premium; you break even at $78.50.
Checklist before establishing a collar
– Confirm you own the underlying shares and quantity (options typically cover 100 shares).
– Select put and call strikes consistent with the protection and upside cap you want.
– Choose expiration date that matches your time horizon for protection.
– Calculate net premium and resulting break-even, max profit, and max loss.
– Check commissions, option liquidity (bid/ask spreads), and assignment risk.
– Consider tax implications and whether option exercise/assignment timing affects taxes.
– Plan an exit: when to close/roll options or let them expire/allow assignment.
Pros and cons
Pros
– Provides a defined downside floor (put strike) for the position.
– Can be implemented for little or no net cost when call premium offsets put premium (credit collar).
– Helps preserve gains while the investor remains long the
underlying while capping upside (call strike). – Can be structured as a zero-cost or net-credit strategy when call premium roughly equals put premium. – Flexible: strikes and expiration let you trade off protection level, cost, and upside potential. – Works as a short- to medium-term hedge without closing the underlying equity position.
Cons
– Caps upside at the short call strike; you may forfeit larger gains if the stock rallies strongly. – If the short call is assigned early (assignment risk), you may be forced to sell the stock before your intended time. – Protection ends at option expiration unless you roll the put (buy a new put). – Transaction costs and wide bid/ask spreads can make collars expensive in practice, especially on less liquid options. – Tax complications: option exercise/assignment and option premium treatment can affect holding periods and realized gains; consult tax guidance.
Worked numeric examples (per share; options typically cover 100 shares)
Assumptions and notation:
– S0 = stock purchase price.
– Kp = put strike (downside protection).
– Kc = call strike (upside cap), with Kp < Kc.
– Pp = premium paid for put.
– Pc = premium received for call.
– Pnet = net premium paid = Pp − Pc (negative if net credit).
Break-even at expiration:
– Break-even price = S0 + Pnet.
Max loss (per share):
– If stock falls below Kp and you exercise the put or are put the shares, Loss = (S0 + Pnet) − Kp.
Max profit (per share):
– If stock rises above Kc and the short call is assigned, Profit = Kc − (S0 + Pnet).
Example A — zero-cost collar
– Buy 100 shares at S0 = $50.
– Buy 1 put at Kp = $45 for Pp = $2.
– Sell 1 call at Kc = $55 for Pc = $2.
– Pnet = 2 − 2 = $0.
– Break-even = 50.
– Max loss = 50 − 45 = $5/share → $500 total.
– Max profit = 55 − 50 = $5/share → $500 total.
Example B — net-credit collar
– Same stock and strikes, but Pp = $1.50 and Pc = $3.00.
– Pnet = 1.5 − 3 = −$1.50 (net credit of $1.50).
– Break-even = 50 − 1.5 = $48.50.
– Max loss = 50 − 1.5 − 45 = $3.50/share → $350.
– Max profit = 55 − (50 − 1.5) = $6.50/share → $650.
Practical checklist to implement a collar
1. Confirm objectives: specify minimum acceptable value (floor) and maximum acceptable sale price (cap). 2. Identify S0 and the number of shares to hedge (options typically control 100 shares). 3. Select Kp and K