Collar

Complete definition

A collar is a hedged equity position that combines long stock with a protective put (downside insurance) and a short call (income to fund the put). Specifically: own 100 shares, buy 1 OTM put below, sell 1 OTM call above. The result: capped upside (limited by the short call strike) and capped downside (limited by the long put strike). A defined-risk equity exposure with insurance built in. Structure: - Long 100 shares of the underlying - Buy 1 OTM put (downside floor) - Sell 1 OTM call (upside cap, funds the put) - Net premium: typically near-zero (the call premium roughly offsets the put cost) → "costless collar" Worked example: AAPL at $185, 30 DTE - Long 100 AAPL shares at $185 ($18,500) - Sell 1 AAPL $195C at $2.20 (collect $220) - Buy 1 AAPL $175P at $1.80 (pay $180) - Net premium: +$40 (small credit) - Position breakdown by AAPL price at expiration: - $175 or below: put exercised, sell shares at $175. Max loss = $1000 + $40 credit = $960 loss. - $175 to $195: stock P&L is the dominant driver + $40 net premium. - $195 or above: call exercised, sell shares at $195. Max profit = $1000 + $40 = $1,040 gain. - Risk range: $960 max loss to $1,040 max gain (capped on both sides) The collar is fundamentally about converting a long equity position into a defined-risk equity position. The trade-off: - **Pros**: Capped downside risk vs naked long stock. Income from the short call. Defined max loss in volatile periods. - **Cons**: Capped upside if the stock rallies past the call strike. Pays for the put insurance (small but non-zero). Collar variations: - **Costless collar**: Call premium ≥ put cost. Pure free insurance, but you give up more upside. - **Negative collar**: Call premium > put cost (net credit). Cap upside aggressively to extract more income. - **Defensive collar**: Larger put protection paid for by tighter call. Useful around earnings or known catalysts. - **Skip-strike collar**: Sell 2 strikes away vs put 1 strike below. Wider upside but cheaper insurance. When to use a collar: - **Concentrated equity position** that would be painful to lose - **Pre-known catalyst** (earnings, regulatory decision) where you want defined risk - **Equity portfolio rebalancing** without taxable disposal — collar limits risk while waiting for tax-friendly exit timing - **Retirement portfolios** seeking smooth equity curves with defined max losses Collars are mathematically equivalent to a long call spread (long call + short higher call), but using the put-stock construction instead. The economics are identical; the construction differs based on which strikes you're hedging. For active equity holders, the collar is one of the most useful risk-management overlays. The capped upside is a real cost, but the defined-risk downside transforms an uncertain equity bet into a predictable risk-managed position.