Loading the player...

What is a 'Collar'

Collar option strategies are a protective strategy that is implemented on a long stock position. An investor can create a collar position by purchasing an out-of-the-money put option while simultaneously writing an out-of-the-money call option. A collar is also known as hedge wrapper. The put protects the trader incase the price of the stock drops. Writing the call produces income (or offsets the cost of buying the put) and allows the trader to profit on the stock up to the strike price of the call, but not higher.

Breaking Down the 'Collar'

Collars, in option trading, describe the position of being long put options, short call options, and long shares of the underlying stock. The call and put should be the same expiry month and the same number of contracts. The strike prices of the call and put are different. The purchased put should have a strike price below the current market price of the stock. The written call should have a strike price above the current market price of the stock.

The strategy is used by traders who are mildly bullish, but who also want to protect against a downside move in the stock. They are also willing to give up gains on the stock above the strike price. Therefore, this strategy is not typically used by traders who are very bullish and expect a large price increase.

Collar Strategy Mechanics

The purchase of an out-of-the-money put option is what protects the trader from a large downward move in the stock price. The price paid to buy the puts is reduced by amount of premium that is collected by selling the out-of-the-money call. 

Collars protect investors against big losses, but collars also prevent big gains because the upside in the stock is limited to the strike price of the call written call option.

The protective collar strategy involves two strategies known as a protective put and covered call. A protective put, or married put, involves being long a put option and long the underlying security. A covered call, or buy/write, involves being long the underlying security and short a call option.

Maximum Profit and Loss

The maximum profit of a collar is equivalent to the call option's strike price less the underlying stock's purchase price per share. The cost of the options, whether for debit or credit, is then factored in. 

The maximum loss is the purchase price of the underlying stock less the put option's strike price. The cost of the option is then factored in.

Collar Example

Assume an investor is long 1,000 shares of stock ABC at a price of $50 per share, and the stock is currently trading at $47 per share. The investor wants to temporarily hedge the position due to the increase in the overall market's volatility.

The investor purchases 10 put options with a strike price of $45 and writes 10 call options with a strike price of $60.

Assume the option positions are implemented for a debit of $1.50, meaning the two option positions costs $1.50 total (per share) to put on.

The maximum profit is $8,500, or 10 contracts x 100 shares x ($60 - $50 - $1.50).  This scenario occurs if the stock prices goes to $60 or above.

Conversely, the maximum loss is $6,500, or 10 x 100 x ($50 - $45 + $1.50). This scenario occurs if the stock price drops to $45 or below.

RELATED TERMS
  1. Zero Cost Collar

    A zero cost collar is an options strategy used to lock in a gain ...
  2. Protective Put

    A protective put is a risk-management strategy that investors ...
  3. Option

    Options are financial derivatives that give the option buyer ...
  4. Stock Option

    Stock options give the holder the right to buy or sell shares ...
  5. Leg

    A leg is one component of a derivatives trading strategy, in ...
  6. Bull Call Spread

    A bull call spread is used when a moderate rise in the underlying ...
Related Articles
  1. Investing

    Long on Oil? Hedge Falling Oil Prices with Options

    With no end to the oil slump in sight, here are some risk management strategies using options to protect your oil positions.
  2. Managing Wealth

    Costless Collars: Because Asset Allocation Is Not Enough

    Collars are extremely flexible, and can be much more beneficial to your portfolio than asset allocation.
  3. Trading

    Index Options: A How-To Guide

    Index options, financial derivatives that derive their value from a stock index, can provide stability and peace of mind for less risky investors.
  4. Trading

    Beginners Guide To Options Strategies

    Find out four simple ways to profit from call and put options strategies.
  5. Investing

    4 Ways to Diversify a Concentrated Stock Position

    Owning too much stock concentrated in one company exposes an investor to significant risk. Learn four strategies to diversify and protect your portfolio.
  6. Trading

    Profiting From Stock Declines: Bear Put Spread Vs. Long Put

    If you're bearish, you should compare the risk/reward characteristics of these two strategies.
  7. Trading

    Strategies for Trading Volatility With Options (NFLX)

    These five strategies are used by traders to capitalize on stocks or securities that exhibit high volatility.
  8. Trading

    4 Popular Options Strategies for 2016

    Learn how long straddles, long strangles and vertical debit spreads can help you profit from the volatility that stock analysts expect for 2016.
  9. Trading

    Bear Put Spreads: An Alternative to Short Selling

    This strategy allows you to stop chasing losses when you're feeling bearish.
RELATED FAQS
  1. How do traders combine a short put with other positions to hedge?

    Learn how sold puts can be utilized in different types of hedging strategies, and understand some of the more common option ... Read Answer >>
  2. How do you use put options to profit from a bear market?

    Learn how traders use put options in their trading strategies to remain profitable, even in a bear market. Everyday investors ... Read Answer >>
  3. Is it more advantageous to purchase a call or put option?

    Learn the advantages of put and call options to choose the right side of the contract to meet your personal investment objectives. Read Answer >>
  4. Can an Option Have a Negative Strike Price?

    When it comes to exchange traded options, an option can't have a negative strike price. Read Answer >>
Trading Center