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Collar Strategy

A collar protects a stock position by combining a covered call and a protective put, creating a defined range of potential outcomes.

The collar is a three-part strategy: you own the underlying stock, sell an out-of-the-money call, and buy an out-of-the-money put. The premium from the call partially or fully offsets the cost of the put, making this a low-cost or even zero-cost hedging strategy. The trade-off is that your upside is capped at the call strike price, while your downside is limited to the put strike price.

Suppose you own 100 shares of MSFT at $400 per share. You buy a $380 put for $5.00 and sell a $420 call for $5.50, creating a net credit of $0.50 per share. Your downside is limited to $400 - $380 - $0.50 = $19.50 per share. Your upside is capped at $420 + $0.50 = $420.50 per share, or a gain of $20.50. The collar locks in a range of outcomes between roughly -4.9% and +5.1% over the life of the options.

Zero-Cost Collars

A zero-cost collar is achieved when the call premium equals the put premium. This requires selecting strike prices where the two premiums offset. For example, with a stock at $100, you might sell a $110 call for $2.00 and buy a $90 put for $2.00. The net cost is zero. Zero-cost collars are popular among executives hedging concentrated stock positions, though tax rules must be carefully considered to avoid constructive sale treatment under Section 1259 of the Internal Revenue Code.

Adjusting the Collar

Collars are dynamic. If the stock rises near the call strike, you can roll the call up and out to capture more upside, often buying back the original call and selling a higher strike with more time. If the stock falls near the put strike, you can roll the put down and out to reduce the cost of continued protection. Many investors use 30-90 day options and adjust their strikes monthly based on market movements and portfolio objectives.

FAQs

Can I lose money with a collar?

Yes. If the stock drops below the put strike, the put protects you only down to that level. The stock could still decline by the distance to the put strike, plus any net debit paid. The collar defines your risk range, it doesn't eliminate loss entirely.

What happens at expiration?

If the stock is between the put and call strikes, both options expire worthless and you keep the stock. If above the call strike, the stock is called away. If below the put strike, you exercise the put and sell at the strike price.

Are collars suitable for all stocks?

Collars work best on stocks with liquid options markets where bid-ask spreads are tight. Highly volatile stocks may have wide option premiums that make it difficult to construct a cost-effective collar.

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