A Collar is similar to a Covered Call with limited risk (Strategy 6) – buying Put Options to insure against the fall in the price of the Stock. So a Collar is buying a stock, insuring against the downside by buying Put Options, and then partly financing the Put Options by selling a Call.

The Put Options generally is ATM and the Call is OTM having the same expiration month and must be equal in the number of shares.

[ATM Put - At the Money: A Put Option is said to be in ATM if the strike price is equal to the current spot price of the security.
OTM - Out of the Money: A Call is said to be in OTM if the strike price is higher than the current spot price of the security.]

This is a low-risk strategy since the Put Options prevents downside risk. However, do not expect unlimited rewards since the Call prevents that. It is a strategy to be adopted when the investor is conservatively bullish. The following example should make the Collar easier to understand:


When to Use: The collar is a good strategy to use if the investor is writing covered calls to earn premiums but wishes to protect himself from an unexpectedly sharp drop in the price of the underlying security.
Risk: Limited.
Reward: Limited.
Breakeven: Purchase Price of Underlying – Call Premium + Put Premium.


Suppose you are holding ABC Ltd., at an average price of ₹4750. You also want to protect yourself from losses in case the stock moves downwards. In such a scenario, you can use the Collar strategy by selling a Call at ₹5000 for a premium of ₹40 and simultaneously buying a Put at ₹4700 for a premium of Rs 30. Both options will be for the same expiry date.

  1. If the price of ABC Ltd. rises to Rs. 5100 after a month, then,

  • You will sell the stock at Rs. 5100 earning a profit of Rs. 350 (Rs. 5100 - Rs. 4750)

  • You will have to pay Rs. 100 when the call sold is exercised

  • The Put option will expire worthlessly

  • Net Profit = Rs. 350 - 100 + 40 - 30 = Rs. 260

This is the maximum return on the Collar Strategy

However, unlike a Covered Call, the downside risk here is also limited:

  1. If the price of ABC Ltd. falls to Rs. 4400 after a month, then,

  • You lose Rs. 350 on the stock ABC Ltd. (Rs. 4750 - Rs. 4400)

  • The Call expires worthless

  • You will earn Rs. 300 when the Put option is exercised

  • Net loss = -350 + 300 - 30 + 40 = - 40

This is the maximum you can lose on the Collar Strategy. The Upside in this case is much more than the downside risk.

Closing Price of ABC Ltd

Short Call Option Payoff

Long Put Option Payoff

ABC Ltd Payoff

Net Payoff

4500

40

170

-250

-40

4600

40

70

-150

-40

4700

40

30

-50

20

4770

40

-30

20

30

4900

40

-30

150

160

5000

40

-30

250

260

5100

-60

-30

350

260

5200

-160

-30

450

260




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