Collars

A collar is a hedging strategy for shares you own. You buy a put to set a floor under your losses and sell a call to set a ceiling on your gains. The premium from the call pays for some or all of the put. The result is a position whose value is fenced in between two prices until expiration. Collars are popular with investors who hold large positions in a single stock, such as employees with company shares, and want protection without paying much for it.

How it works#

1. Own 100 shares per contract.
2. Buy an out of the money put below the current price: your floor.
3. Sell an out of the money call above the current price: your ceiling.
4. Net cost = put premium minus call premium. If they are equal, it is a zero cost collar.

Payoff at a glance#

Worked example#

Why collars are popular#

• Cheap protection: the call premium offsets the put cost.
• Defer selling: investors can protect a large gain without selling and triggering tax immediately (tax rules on hedged positions vary by country, so check with a professional). See Trading Taxes and Capital Gains.
• Concentrated positions: executives and long term holders use collars to reduce single stock risk. See Concentration Risk.

Choosing strikes#

Because of volatility skew, out of the money puts on stocks and indices usually cost more than equally distant calls, so a zero cost collar often has its call strike closer to the current price than its put strike. See Volatility Smile and Skew.

A collar is a bull call spread in disguise#

By put call parity, long stock plus long put plus short call has the same payoff as a bull call spread plus cash, at the same strikes. Understanding this helps compare costs and margin. See Synthetic Positions and Bull Call Spread.

Managing a collar#

• Roll the collar forward at expiration to keep protection.
• Reset strikes after big moves, for example raising both after a rally.
• Watch for early assignment on the short call, especially near dividends. See Exercise and Assignment.
• Close both legs together if you no longer need protection.

Common mistakes#

• Setting the call strike too low, giving away most upside.
• Forgetting the call can be assigned early.
• Ignoring tax consequences of hedging or assignment.
• Using collars on stocks you expect to rise strongly.

Frequently asked questions#

What is a collar in options?#

A strategy that holds shares, buys a protective put and sells a call, limiting both losses and gains between the two strikes.

What is a zero cost collar?#

A collar where the premium from selling the call equals the cost of buying the put, so the protection costs nothing up front.

When should you use a collar?#

When you want to protect a large gain or concentrated position for a period and are willing to cap upside in exchange.

Next, see how options combine to recreate other positions in Synthetic Positions.