What Is a Collar Strategy in Options Trading?
A collar is an options strategy where you own 100 shares of a stock, buy a protective put to limit your downside, and sell a call to help pay for that put. It’s a way to protect gains on a stock you already hold, in exchange for giving up some upside potential.
Think of it like putting a floor and a ceiling around your stock position. Here’s how each part works and when this strategy makes sense.
Key Takeaways
- A collar combines owning stock, buying a protective put, and selling a covered call, all at the same time.
- The put sets a floor on how much you can lose, while the sold call sets a ceiling on how much you can gain.
- Selling the call helps offset, or sometimes fully covers, the cost of buying the put.
- Collars are often used to protect unrealized gains on a stock without selling the shares outright.
- The tradeoff is limited upside, since the sold call caps your profit if the stock rallies hard.
The Three Parts of a Collar
A collar strategy has three pieces working together:
- Own the stock. You need at least 100 shares to sell one call contract against them, which is the “covered” part of the trade.
- Buy a protective put. This gives you the right to sell your shares at a set strike price, putting a floor under your potential losses.
- Sell a covered call. This brings in premium income, which helps pay for the put, but it caps your gains if the stock rises above the call’s strike price.
Because the sold call’s premium often offsets much or all of the put’s cost, this is sometimes called a “costless collar,” though in practice, small differences between the two premiums are common, so it’s rarely exactly free.
A Simple Example
Suppose you own 100 shares of a stock currently trading at $80, and you’ve got a solid unrealized gain you’d like to protect without selling.
- You buy a put with a $75 strike price for $2.00 per share ($200).
- You sell a call with a $85 strike price for $2.00 per share ($200).
- The premium you collect from the call exactly offsets the cost of the put in this example, so your net cost is $0.
Now your position is “collared” between $75 and $85:
- If the stock falls to $60, your put lets you sell at $75, limiting your loss to the drop from $80 to $75.
- If the stock rises to $100, your shares get called away at $85, capping your gain at the move from $80 to $85, even though the stock kept climbing.
- If the stock stays between $75 and $85, both options expire worthless, and you simply keep your shares.
Why Use a Collar?
In practice, most investors turn to a collar when they’ve built up a meaningful gain in a stock and want to protect it from a sudden downturn, without selling shares and triggering a taxable event or giving up their position entirely.
It’s also used by investors who want downside protection but don’t want to pay full price for a protective put on its own, since the sold call helps cover that cost.
Collar vs. Protective Put vs. Covered Call
| Feature | Protective Put Alone | Covered Call Alone | Collar |
|---|---|---|---|
| Downside protection | Yes, floor set by put | No | Yes, floor set by put |
| Upside potential | Unlimited (minus put cost) | Capped at strike price | Capped at call’s strike price |
| Upfront cost | You pay a premium | You collect a premium | Often near zero, since premiums can offset |
| Best for | Protecting gains, willing to pay for it | Generating income, comfortable capping gains | Protecting gains at low or no net cost |
When Does a Collar Make Sense?
A collar tends to fit investors who already hold a stock and have a bullish long-term view, but want temporary protection during a period of uncertainty, such as before an earnings report or during a broader market downturn.
It’s less useful if you expect the stock to make a big move upward soon, since the sold call limits how much of that move you get to keep.
Setting Up a Collar Step by Step
- Confirm you own at least 100 shares of the stock (or a multiple of 100).
- Choose a put strike price below the current stock price that sets your desired floor.
- Choose a call strike price above the current stock price that sets your desired ceiling.
- Compare the premiums to see your net cost or credit for the trade.
- Monitor the position, especially as expiration approaches or if the stock approaches either strike price.
Risks and Limitations
A collar reduces risk compared to holding stock alone, but it doesn’t remove risk completely. You can still lose money between the current stock price and your put’s strike price. There’s also assignment risk on the sold call, meaning your shares could be called away earlier than expected, particularly around dividend dates. As with any options strategy, it helps to fully understand the tradeoffs, including the capped upside, before placing the trade.
Frequently Asked Questions
Do I need to own the stock to set up a collar?
Yes. A collar requires owning at least 100 shares, since the strategy pairs a protective put with a covered call written against those shares.
Is a collar the same as a costless collar?
A costless collar is a specific version of a collar where the premium from the sold call fully offsets the cost of the bought put. Not every collar works out to exactly zero net cost.
What happens if my stock gets called away in a collar?
If the stock rises above your call’s strike price and you’re assigned, your shares are sold at that strike price. You keep the premium collected and any gain up to that strike, but you no longer own the stock.
Can I lose money with a collar strategy?
Yes. You can still lose value if the stock falls between the current price and your put’s strike price, since the put only protects you below its strike price, not above it.
How long should a collar stay in place?
There’s no fixed rule. Some investors use collars for a specific event, like an earnings announcement, while others keep a collar in place for months to protect a long-term position during uncertain conditions.
