Collar

What is a Collar?

A collar is a three-part position: you own 100 shares of a stock, you buy a protective put below the current price, and you sell a covered call above it. The put protects your downside. The call caps your upside. The premium from selling the call offsets (partially or fully) the cost of buying the put.

Think of it as a protective put with a built-in way to pay for the insurance. You give up some upside potential in exchange for nearly free downside protection. It is the ultimate "sleep well at night" strategy for stock holders.

How to Set It Up

• Own 100 shares of the underlying stock
• Buy 1 OTM put below the current stock price (the protection)
• Sell 1 OTM call above the current stock price (to pay for the put)
• Same expiration for both options
• Strike selection: Common setup is to buy a put 5-10% below and sell a call 5-10% above current price. Adjust based on how much protection you want and how much upside you are willing to give up.
• Expiration: 30-90 days depending on how long you need the hedge.

If the premium from the call covers the cost of the put, you have a zero-cost collar. This is the ideal setup.

When to Use This Strategy

Use a collar when:

• You have big unrealized gains on a stock and want to protect them
• A risky event is coming (earnings, regulatory decision) and you do not want to sell your shares
• You are near retirement or have a concentrated position and cannot afford a big drawdown
• Tax considerations prevent you from selling (you would trigger a big capital gains bill)
• You want downside protection but do not want to pay for it out of pocket

The collar is the strategy of choice for executives holding company stock, investors with concentrated positions, and anyone who needs to protect gains without selling.

Example Trade

You own 100 shares of XYZ at $100. You have big gains and do not want to sell for tax reasons, but you are worried about a pullback.

• Buy 1 XYZ $95 put for $2.00 (protection)
• Sell 1 XYZ $108 call for $2.00 (pays for the put)
• Net cost: $2.00 - $2.00 = $0 (zero-cost collar)

Scenario 1: XYZ drops to $80. Without the collar, you lose $2,000. With the collar, your put is worth $15. Your stock lost $20 per share but the put gained $15 after its cost. Net position: shares at $80 + put worth $15 = effectively $95 per share. Max loss is ($100 - $95) x 100 = $500.

Scenario 2: XYZ goes to $120. Your shares gained $20, but your call caps you at $108. You sell at $108 for an $800 gain. You miss the extra $12 move from $108 to $120, but $800 profit is still solid.

Scenario 3: XYZ stays at $100. Both options expire worthless. You still own your shares and it cost you nothing.

Risk and Reward

• Max profit: (Call strike - stock cost +/- net premium) x 100. In our zero-cost collar example, ($108 - $100) x 100 = $800.
• Max loss: (Stock cost - put strike +/- net premium) x 100. ($100 - $95) x 100 = $500.
• Breakeven: Your stock cost, adjusted for any net premium paid or received. In a zero-cost collar, your breakeven is the same as your stock cost.

The beauty is that your worst case is defined. No matter what happens, you cannot lose more than the distance between the stock price and the put strike (plus any net premium if the collar was not zero-cost).

Tips and Common Mistakes

• Aim for a zero-cost collar when possible. Match the put cost with the call premium. This way the hedge is free and your only "cost" is capping your upside.
• Do not set the call strike too close. If you sell a $102 call on a $100 stock just to get a fatter premium, you are giving up almost all your upside. Give the stock room to run.
• Roll the collar forward. As expiration approaches, you can close both options and open new ones at new strikes and a later expiration. This keeps the protection going.
• Understand the tax implications. Collars on individual stocks can sometimes create issues with tax treatment of the stock position. If you have significant gains, consult a tax professional before putting on a collar.

Related Strategies

• Protective Put — the downside protection piece without the call
• Covered Call — the income piece without the put protection
• The Wheel — if you do not need protection and just want income