Collar Strategy

What is a Collar Strategy?

A collar is a protective put with a twist: you sell a call to pay for (or reduce the cost of) the put. You own 100 shares, buy a protective put for downside insurance, and sell an out-of-the-money call to finance that insurance. The result? Free or low-cost protection in exchange for capping your upside.

Think of it as a "costless collar" around your stock position—you've created a floor (the put) and a ceiling (the short call), locking your position into a defined range. This is immensely popular with executives, employees with company stock, and investors holding concentrated positions who want protection without paying for it.

The classic setup: Stock at $100, buy $95 put for $2, sell $110 call for $2. Net cost: $0. Your stock is now locked between $95-$110 for the life of the collar.

When to Use Collar Strategies

1. Employee Stock Lockup Periods

You work at a tech company, your $200K in stock just vested, but you can't sell for 6 months. A collar protects you from a crash without violating lockup restrictions (options typically aren't restricted, check your company policy).

2. Tax-Deferred Protection

You bought Amazon 5 years ago at $100, it's now $180 with $80K in unrealized gains. Selling triggers $16K+ in taxes. A collar protects your gains for another 12+ months while qualifying for long-term capital gains treatment.

3. Market Uncertainty with Limited Upside Expectations

You think the market is due for a 10-20% correction, but don't believe there's much upside in the next 6 months. Collar locks in current value while surrendering upside you don't expect anyway.

4. Pre-Retirement Risk Reduction

You're 2-3 years from retirement with $1M portfolio. Can't afford a 30% crash but don't want to sell everything. Collar 50-70% of your portfolio to lock in gains while retaining some upside.

How to Set Up a Collar

Step-by-Step Setup

Example: Own 500 shares of Microsoft at $380 (cost basis $300)

1. Buy protective puts (5-10% OTM):
Buy 5 MSFT $360 puts (5.3% OTM), 180 days to expiration
Cost: $10 per share = $5,000 total

2. Sell OTM calls:
Sell 5 MSFT $420 calls (10.5% OTM), 180 days to expiration
Credit: $9 per share = $4,500 received

3. Net cost:
$5,000 paid - $4,500 received = $500 net cost (0.26% of position)
Alternatively, you can adjust strikes to make it zero-cost or even a credit.

Strike Selection Guidelines

Protective Put Strike:

• 5% OTM: Good protection, moderate cost
• 10% OTM: Accept more downside, lower cost
• ATM: Maximum protection, highest cost (call premium won't fully offset)

Short Call Strike:

• 5-7% OTM: Collects good premium, but limits upside quickly
• 10-15% OTM: Better upside potential, collects less premium
• 20%+ OTM: Lots of upside room, but won't offset put cost

Pro tip: Start with your desired call strike (how much upside you're willing to give up), then find the put strike that makes the collar zero-cost or close to it.

Profit & Loss Scenarios

Using MSFT example: Own at $380, $360 put / $420 call collar for $500 net cost

Scenario 1: Crash to $300

• Stock loss: -$80 per share (-$40,000 total)
• Put gain: +$60 per share (+$30,000) [$360 strike - $300 price]
• Call expires worthless: $0
• Net position value: $360 per share vs $300 market price
• Total loss: -$20 per share + $1 collar cost = -$21 (vs -$80 unprotected)

Scenario 2: Sideways at $380

• Stock: unchanged
• Put expires worthless: -$10
• Call expires worthless: +$9
• Total cost: -$1 per share ($500 total insurance cost)

Scenario 3: Rally to $450

• Stock gain: +$70 per share
• Put expires worthless: -$10
• Call assigned: -$30 per share [$450 price - $420 call strike]
• Total gain: +$40 per share - $1 collar cost = +$39 (vs +$70 unprotected)

Key insight: Downside protected below $360, upside capped at $420. You've locked in a $60 range (15.8%) for near-zero cost.

Types of Collars

Zero-Cost Collar

Call premium exactly offsets put cost. Most popular type.

• Advantage: Free protection
• Disadvantage: Upside is typically capped at 5-10% above current price

Debit Collar

Put costs more than call premium collected. You pay net premium.

• Advantage: Call strike further OTM (more upside potential)
• Disadvantage: Costs money (1-3% typically)
• Best for: Moderate upside expectations, want protection but retain some gains

Credit Collar (Rare)

Call premium exceeds put cost. You receive net credit.

• Advantage: Get paid to protect your position!
• Disadvantage: Very tight upside cap (usually 2-5% above current price)
• Best for: Very bearish, want protection and don't care about limited upside

Collar vs Alternative Strategies

Collar vs Protective Put

Collar vs Covered Call

A covered call sells a call for income without buying downside protection. A collar adds the protective put.

• Covered call: Generate income, exposed to full downside
• Collar: No income (premium offsets protection), protected downside

Managing Your Collar

If Stock Rallies Near Call Strike

Option 1: Let shares be called away. You're capped anyway, take the gain.

Option 2: Roll up and out. Buy back the short call, sell a new call at a higher strike further out in time. This extends the collar and raises your ceiling.

Example: Stock at $118, your $120 call expiring in 30 days. Buy it back for $5, sell the 90-day $130 call for $6. Net $1 credit, new ceiling at $130.

If Stock Drops Near Put Strike

Good news: you're protected! Your put is gaining value as stock falls.

Option 1: Hold the collar, let the put protect you.
Option 2: Close the entire position (sell stock + close options) to realize losses for tax purposes.
Option 3: Roll down. Close current collar, sell stock, buy new shares at lower price with new collar.

At Expiration

With 30-45 days left:

• If still want protection: Close current collar, establish new 6-month collar
• If no longer need protection: Let it expire, keep stock unhedged
• If want to sell: Close collar and sell stock

Advanced Collar Techniques

1. The Partial Collar

Own 1,000 shares but only collar 500. This gives you 50% downside protection while retaining full upside on half your position.

2. Quarterly Rolling Collar

Instead of 6-12 month collars, use 45-90 day collars and roll quarterly. This allows you to adjust strikes based on market conditions and stock performance every quarter.

3. Asymmetric Collar

Willing to accept more downside risk? Buy puts 15% OTM, sell calls 5% OTM. You collect a net credit, have wide downside buffer, but tight upside cap. Good for slightly bearish outlook.

Key Takeaways