A collar is one of the smartest ways to protect a stock position. It combines a protective put with a covered call to create low-cost or even free protection. This guide explains how collars work and when to use them.
What is a Collar?
A collar strategy involves three positions: owning 100 shares of stock, buying a protective put below the current price, and selling a covered call above the current price. The premium from selling the call offsets the cost of buying the put.
Simple version: You get downside protection (the put) and pay for it by giving up some upside (the call). If the premiums match, you get free insurance. The trade-off is your profit is capped if the stock rallies.
The Three Parts of a Collar
- Stock: Own 100 shares
- Protective put: Buy a put below current price (floor for losses)
- Covered call: Sell a call above current price (ceiling for gains)
Example: Setting Up a Collar
You own 100 shares of ABC at $100 ($10,000 total).
- Buy a $90 put for $2.50 (cost: $250)
- Sell a $110 call for $2.50 (credit: $250)
- Net cost: $0 (zero-cost collar)
Your position now has:
- Downside protected below $90 (floor)
- Upside capped at $110 (ceiling)
- Between $90 and $110, you participate normally
How the Collar Performs
Stock Crashes (to $70)
- Stock loss: -$3,000
- Put profit: +$2,000 ($90 - $70 = $20 x 100)
- Call expires worthless
- Net loss: -$1,000 (10% instead of 30%)
Stock Stays Flat ($100)
- Stock: No change
- Put expires worthless
- Call expires worthless
- Net result: $0 (you kept your shares)
Stock Rallies (to $130)
- Stock sold at $110 (call exercised)
- Put expires worthless
- Net profit: +$1,000 (10%)
- You missed $20 of upside
Why Use a Collar?
- Low or no cost protection: The call pays for the put
- Sleep better: Your downside is defined
- Stay invested: You keep your shares (unless they rally past the call)
- Tax benefits: You do not trigger a sale by buying protection
When to Use a Collar
- Big unrealized gains: You want to protect profits but not sell yet
- Concentrated positions: A large portion of your wealth is in one stock
- Before uncertain events: Earnings, elections, or economic data
- Retirement planning: Protecting wealth as you approach retirement
- Company stock: Employees with lots of stock in their employer
Zero-Cost vs Paid Collars
Zero-Cost Collar
Call premium equals put premium. No out-of-pocket cost. Usually means tighter strikes (less upside, more protection).
Debit Collar
Put costs more than call credit. You pay net premium. Gives more upside room or tighter protection.
Credit Collar
Call credit exceeds put cost. You receive net premium. Usually means distant put (less protection) or tight call (less upside).
Example: Different Collar Configurations
Stock at $100:
Zero-cost: Buy $90 put ($2.50), Sell $110 call ($2.50). Net: $0
Debit collar: Buy $95 put ($4.00), Sell $115 call ($2.00). Net: -$2.00 (pay $200)
Credit collar: Buy $85 put ($1.50), Sell $105 call ($3.00). Net: +$1.50 (receive $150)
Choosing Strike Prices
The strikes you choose determine your risk-reward profile:
- Tighter put: More protection but costs more (need to sell tighter call)
- Wider put: Less protection but cheaper (can keep more upside)
- Tighter call: More premium but less upside potential
- Wider call: More upside but less premium to offset put
Tip: Start by deciding how much downside you can tolerate. Pick the put strike first. Then find a call that pays for it while leaving acceptable upside.
Collar vs Protective Put
| Collar | Protective Put | |
|---|---|---|
| Cost | Low or zero | Premium paid |
| Upside | Capped | Unlimited |
| Downside | Protected | Protected |
| Best for | Cost-conscious protection | Keeping full upside |
Managing Your Collar
- Stock rises to call strike: Decide whether to let shares be called away or roll the call higher
- Stock falls to put strike: Decide whether to exercise the put or sell it and keep shares
- Approaching expiration: Roll both legs to a new expiration if you want continued protection
Track Your Collar Positions
Pro Trader Dashboard shows all three legs of your collar together. See your protected range, breakeven, and potential outcomes at a glance.
Summary
A collar strategy combines owning stock with a protective put and a covered call. The call premium pays for the put, giving you low-cost or free downside protection. The trade-off is your upside is capped. Collars are ideal for protecting gains on concentrated positions or reducing risk before uncertain events while staying invested in the stock.
Want to learn more? Check out protective puts for unlimited upside protection or covered calls for income generation.