What Is a Collar Strategy?
A collar strategy combines three positions: owning shares of stock, buying a protective put below the current price, and selling a covered call above the current price. The put provides downside protection while the call premium helps offset the put cost. The result is a position with both capped upside and capped downside, creating a defined-risk range for your stock investment.
Collars are popular among investors who own appreciated stock and want to protect gains without selling shares. They are especially common before uncertain events (elections, earnings seasons, market corrections) and for concentrated stock positions. The collar can often be structured for zero cost when the call premium equals the put premium.
When the premium received from selling the call equals the premium paid for the put, the collar costs nothing to implement. This is called a zero-cost collar and provides free downside protection at the expense of capping your upside at the call strike price.
Collar Formulas
- 1Net collar cost = $2.00 - $2.00 = $0 (zero-cost collar)
- 2Max profit = ($110 - $95 + $0) × 100 = $1,500
- 3Max loss = ($95 - $90 + $0) × 100 = $500
- 4Breakeven = $95 + $0 = $95 (purchase price, since collar is free)
- 5Stock above $110: shares called away, profit capped at $1,500
- 6Stock below $90: put protects, max loss = $500
- 7Stock between $90-$110: normal stock P&L
| Stock Price | Stock P&L | Put Value | Call Obligation | Total P&L |
|---|---|---|---|---|
| $80 | $-1,500 | $1,000 | $0 | -$500 (max loss) |
| $90 | -$500 | $0 | $0 | -$500 (max loss) |
| $95 | $0 | $0 | $0 | $0 (breakeven) |
| $100 | +$500 | $0 | $0 | +$500 |
| $110 | +$1,500 | $0 | $0 | +$1,500 (max) |
| $120 | +$2,500 | $0 | -$1,000 | +$1,500 (capped) |
Implementing a Collar
- Collars are the safest options strategy for stock holders
- Zero-cost collars provide free protection but cap upside
- Popular for executives with concentrated stock positions
- Can be adjusted by moving strikes as the stock price changes
- Tax-efficient: no capital gains event from implementing the collar
A narrow collar ($95 put / $105 call on $100 stock) provides tight protection but limits upside. A wide collar ($85 put / $120 call) allows more upside but provides less protection. Match the width to your risk tolerance and expected stock movement.
In the US, implementing a collar can potentially trigger the constructive sale rule if both options are too close to ATM, causing a taxable event on your stock gains. Consult a tax professional before implementing collars on stocks with significant unrealized gains.
Advanced Trading Concepts: Risk-Adjusted Returns
Evaluating investment performance requires going beyond raw returns to measure risk-adjusted returns. The Sharpe ratio (excess return divided by standard deviation) is the most commonly used metric, measuring how much return you generate per unit of volatility. A Sharpe ratio above 1.0 is considered good; above 2.0 is excellent. Options strategies can sometimes appear to have very high Sharpe ratios historically, but this can be misleading because options strategies often have negatively skewed returns — small consistent gains punctuated by occasional large losses that do not show up in short historical periods. The Sortino ratio (which only penalizes downside volatility) and maximum drawdown are better supplements to the Sharpe ratio for options-based strategies.
Portfolio-level risk management for options positions requires understanding the correlation between your different positions. During market stress events (rapid selling, volatility spikes), options strategies that appear uncorrelated in calm markets often move together. A portfolio of covered calls on 10 different stocks appears diversified, but in a market crash scenario, all positions lose money simultaneously as stocks fall and volatility spikes. True diversification requires mixing options strategies with different directional exposures (long and short delta), different vega profiles (long and short volatility), and potentially different asset classes (equities, commodities, rates). Position-level delta and portfolio-level Greek monitoring is essential for serious options traders managing multiple positions.
