What if you could protect your stock position from a major decline without paying a penny? The costless collar, also called a zero-cost collar, makes this possible. By carefully selecting your strike prices, you can create downside protection that pays for itself. In this guide, we will show you exactly how it works.
What is a Costless Collar?
A costless collar is a variation of the standard collar strategy where the premium received from selling the call option exactly offsets the premium paid for the protective put. The result is downside protection with zero out-of-pocket cost.
The simple version: You sell a call that generates enough money to buy a put. Your protection is free, but you give up gains above the call strike.
How to Create a Costless Collar
The key is finding strike prices where the premiums match:
- Own 100 shares of stock
- Find a put strike where the premium equals an available call premium
- Sell the call and buy the put for net zero cost
Example
You own 100 shares at $100 and want free protection.
- The $92 put costs $3.00
- The $108 call pays $3.00
- Buy the put and sell the call: net cost $0
You are now protected below $92 and capped at $108, with no money spent.
Finding the Right Strike Combination
Here is how to identify costless collar opportunities:
- Check the options chain: Look at puts below current price and calls above
- Compare premiums: Find where a put premium matches a call premium
- Adjust if needed: Move strikes closer together if you cannot find an exact match
- Consider expiration: Longer expirations offer more strike combinations
Profit and Loss Scenarios
Using our example with a $92 put and $108 call:
Stock Falls to $80
- Your shares lose $20 ($2,000)
- Your put is worth $12 ($1,200)
- Short call expires worthless
- Net loss: $8 per share ($800)
Without protection, you would have lost $2,000. The collar saved you $1,200.
Stock Rises to $120
- Your shares gain $20, but you must sell at $108
- Your put expires worthless
- Net gain: $8 per share ($800)
You miss $12 of upside but still profit from the move.
Stock Stays at $100
- Both options expire worthless
- Your stock position is unchanged
- You paid nothing for the protection you had
The Trade-Off: Protection vs Upside
Costless collars require accepting limitations:
- What you get: Free downside protection to the put strike
- What you give up: All gains above the call strike
- The catch: To make it costless, you often need to sell calls at strikes closer to the current price
Costless vs Paid Collar Comparison
Stock at $100:
- Costless collar: $92 put / $108 call = $0 cost, $8 max gain, $8 max loss
- Paid collar: $90 put for $2 / $115 call for $1 = $1 cost, $15 max gain, $10 max loss
The paid collar costs $1 but offers nearly double the upside potential.
When Costless Collars Make Sense
This strategy is ideal in certain situations:
- High implied volatility: Options are expensive, making costless structures easier to create
- Large gains to protect: You have significant unrealized profits
- Tax constraints: Selling would trigger a large capital gains bill
- Uncertain outlook: You are neutral to slightly bullish but worried about downside
Factors Affecting Costless Collar Construction
Several factors determine whether a costless collar is achievable:
- Implied volatility: Higher IV means more premium, making it easier to match puts and calls
- Time to expiration: Longer dates provide more flexibility in strike selection
- Dividend yield: High-dividend stocks have lower call premiums, making costless collars harder
- Skew: Put options often cost more than equidistant calls due to demand for protection
Managing Your Costless Collar
Once established, monitor and adjust as needed:
- If the stock rises to your call strike: Decide whether to buy back the call or let shares be called away
- If the stock falls to your put strike: Exercise the put or sell it and keep the shares
- As expiration approaches: Roll to a new expiration to maintain protection
- If volatility spikes: You may be able to close for a profit
Tax Implications
Costless collars have the same tax considerations as regular collars:
- The collar itself does not trigger a taxable event
- Very tight costless collars may constitute a constructive sale
- The IRS looks at the overall risk reduction to determine this
- Ensure your collar leaves meaningful upside to avoid issues
Build and Track Costless Collars
Pro Trader Dashboard helps you find costless collar opportunities and tracks your protected positions with real-time P/L and expiration alerts.
Common Mistakes to Avoid
- Chasing exact zero cost: Sometimes paying a small debit gets much better strikes
- Ignoring the skew: Puts often cost more than calls, so costless may mean tight strikes
- Forgetting dividends: Your call may be assigned early before ex-dividend dates
- Not monitoring: Stock moves can create opportunities to adjust
Summary
The costless collar provides free downside protection by using call premium to pay for put protection. While you give up upside above the call strike, you gain peace of mind without spending any money. This strategy works best when implied volatility is high and you have significant gains to protect. Remember that "free" protection still has a cost: your capped upside potential.
Want more flexibility? Learn about the standard collar strategy or explore synthetic stock positions for different ways to manage risk.