What a collar does
A collar wraps shares you already own in two options. You buy a put below the price, which sets a floor on what the shares can be worth at expiry. You sell a call above the price, which pays for some or all of the put and caps what you can make. The result is a range: you cannot lose more than the floor or gain more than the cap until the options expire.
net cost = put premium − call premium
worst case = (put strike − price − net cost) × shares
best case = (call strike − price − net cost) × shares
A worked example
With the figures loaded above you hold 100 shares at $100, bought at $70. For 90 days you buy the 90 put for $1.12 and sell the 110 call for $1.89.
- Net cost is $1.12 − $1.89 = −$0.77: the collar pays you $77, because the call is worth more than the put.
- Worst case from today is ($90 − $100 + $0.77) × 100 = −$923, a 9.2% fall, however far the shares drop.
- Best case is ($110 − $100 + $0.77) × 100 = +$1,077, however far they rise.
- Against your $70 cost, you lock in at least $2,077 of gain and at most $4,077.
A zero-cost collar picks strikes so the two premiums cancel. Because puts are often priced at higher implied volatility than calls the same distance away, the call usually has to sit closer to the price than the put for the premiums to match.
When a collar makes sense, and what it costs
- A large gain you do not want to give back, often in a concentrated position or ahead of a known event, is the classic case. The collar protects the gain without selling the shares now.
- The cost is the upside. A zero-cost collar is not free; you pay with every dollar above the call strike.
- Assignment. If the shares finish above the call strike, they are sold at the strike. If you want to keep them, you must roll or buy back the call first.
- Tax. In some countries a tight collar can be treated as a sale for tax purposes, or affect your holding period. Check before using one on a large gain.
For a whole portfolio rather than one holding, index puts are usually cheaper: see hedging a portfolio with SPY puts and the beta-weighted hedge calculator. The call side on its own is a covered call.