You own a stock that has appreciated nicely, but you are worried about a potential pullback. You do not want to sell because of taxes or because you believe in the long-term story. The collar strategy offers a solution: protect your downside while keeping some upside potential. In this guide, we will explain how collars work and when to use them.
What is a Collar Strategy?
A collar is a three-part position that protects your stock holdings. You own 100 shares, buy a protective put option below the current price, and sell a covered call above the current price. The call premium you receive helps pay for the put protection.
The simple version: A collar puts a floor under your stock (the put protects you from big losses) and a ceiling above it (the call caps your gains but generates income to pay for protection).
How to Set Up a Collar
A collar requires three components:
- Own 100 shares of stock
- Buy 1 OTM put option (below current price)
- Sell 1 OTM call option (above current price)
Example
You own 100 shares of stock at $100 and want protection.
- Buy 1 $90 put for $2.00
- Sell 1 $110 call for $2.50
- Net credit: $0.50 ($50 per collar)
You are now protected below $90 and capped at $110, with $50 in your pocket.
Understanding Your Risk and Reward
Let us break down the possible outcomes:
Stock Falls to $80
- Your shares lose $20 ($2,000)
- Your put is worth $10 ($1,000)
- Your short call expires worthless
- Net loss: $10 per share minus $0.50 credit = $9.50 ($950)
Without the collar, you would have lost $2,000. The put saved you $1,000.
Stock Rises to $120
- Your shares gain $20, but you must sell at $110
- Your put expires worthless
- Your call is exercised at $110
- Net gain: $10 per share plus $0.50 credit = $10.50 ($1,050)
You miss out on $10 of gains but still profit nicely.
Stock Stays at $100
- Your shares are unchanged
- Both options expire worthless
- You keep the $0.50 credit ($50)
Maximum Gain and Loss
With a collar, your outcomes are bounded:
- Maximum gain: (Call strike - stock cost) + net credit = ($110 - $100) + $0.50 = $10.50 per share
- Maximum loss: (Stock cost - put strike) - net credit = ($100 - $90) - $0.50 = $9.50 per share
When to Use a Collar
Collars work best in these situations:
- Large unrealized gains: You want to protect profits without triggering a taxable sale
- Concentrated positions: A single stock makes up too much of your portfolio
- Upcoming uncertainty: Earnings, elections, or economic events create risk
- Long-term holdings: You plan to hold for years and want to sleep better
Choosing Your Strike Prices
Strike selection determines your risk-reward profile:
Wider Collar (More Room to Move)
- Put strike further below current price
- Call strike further above current price
- Less protection but more upside potential
- Often results in a small debit
Tighter Collar (More Protection)
- Put strike closer to current price
- Call strike closer to current price
- Better protection but limited upside
- Usually results in a credit
Managing Your Collar
Once established, you have several management options:
- Let it expire: If the stock stays between strikes, both options expire worthless
- Roll the collar: As expiration approaches, roll to a new expiration to maintain protection
- Remove the ceiling: If the stock rises, buy back the call to capture more upside
- Exercise the floor: If the stock crashes, exercise your put to sell at the strike price
Collar vs Protective Put
How does a collar compare to just buying a put?
- Cost: Collar is cheaper (or even generates credit); protective put costs premium
- Upside: Collar caps gains; protective put has unlimited upside
- Downside: Both provide floor protection
- Best for: Collar works when you accept capped gains for cheaper protection
Tax Considerations
Collars have important tax implications:
- A collar does not trigger a sale of your stock
- However, a very tight collar may be treated as a "constructive sale" by the IRS
- This could accelerate your capital gains taxes
- Keep put strikes at least 15-20% below current price to be safe
- Consult a tax advisor for your specific situation
Track Your Collar Positions
Pro Trader Dashboard tracks your stock holdings alongside your options positions. See your protected range, potential outcomes, and time decay all in one view.
Common Mistakes to Avoid
- Setting strikes too tight: Can trigger constructive sale rules
- Forgetting about dividends: Ex-dividend dates can cause early assignment of your call
- Ignoring the cost basis: Your original purchase price matters for calculating true risk
- Not rolling in time: Let options expire and you lose protection
Summary
The collar strategy is an excellent tool for protecting stock positions without selling. By combining a protective put with a covered call, you create a bounded range of outcomes. You sacrifice some upside potential in exchange for downside protection that is often free or even pays you. Use collars when you want to sleep better at night without triggering taxes or giving up your long-term position.
Want to eliminate the cost entirely? Check out our guide on costless collars or learn about credit spreads for income-generating strategies.