What is a collar?
A collar is an options strategy for an investor who already owns stock and wants to protect against a meaningful decline without paying the full cost of a protective put.
1
Own the stock
You begin with 100 shares for each collar you create.
2
Sell to Open a Call
You collect premium, but agree that your shares may be sold at the call strike if assigned.
3
Buy to Open a Put
You pay premium for the right to sell your shares at the put strike, creating downside protection.
Simple mental model:
The put acts like insurance on your stock.
The covered call helps pay the insurance premium.
The put acts like insurance on your stock.
The covered call helps pay the insurance premium.
When should a new investor consider a collar?
| Situation | Does a collar fit? | Why |
|---|---|---|
| You own a stock and are worried about a near-term decline | Often yes | The put limits downside below a selected price. |
| You want to keep the stock but are willing to cap some upside | Often yes | The call finances protection in exchange for limiting gains above the call strike. |
| You have a large unrealized gain and do not want to sell immediately | Potentially | A collar may reduce downside risk without immediately selling the shares. |
| You strongly expect the stock to surge | Usually not ideal | The covered call caps upside above its strike. |
| You do not own the shares | Not a standard collar | A traditional collar starts with an existing long stock position. |
| Your goal is maximum premium income | Not primarily | A collar is mainly about risk management, not maximizing option income. |
MCD example
Assume you already own 100 shares of McDonald's (MCD). The prices below are illustrative, not current market quotes.
| Position | Example | Cash flow | Purpose |
|---|---|---|---|
| Own stock | 100 MCD shares | Existing position | Maintain ownership |
| Sell to Open Call | $300 strike call | Receive $4.00/share = +$400 | Generate income; accept sale of shares at $300 if assigned |
| Buy to Open Put | $270 strike put | Pay $3.00/share = -$300 | Protect stock below $270 |
Net option credit = $400 call premium - $300 put premium = +$100
In this example, the call fully pays for the protective put and leaves a $100 net credit.
In other markets, the collar could instead have a small net cost.
What happens at expiration?
| MCD price at expiration | $300 Call | $270 Put | Likely result |
|---|---|---|---|
| Above $300 | In the money | Expires worthless | Your 100 shares may be sold at $300. Your upside is effectively capped near that level, plus net premium. |
| $270 to $300 | Likely worthless | Likely worthless | You keep the shares. The collar has served as protection during the period without being triggered. |
| Below $270 | Likely worthless | In the money | The put gains value and gives you the right to sell the stock at $270, limiting further downside. |
| Far below $270 | Worthless | Protection active | Your stock loses value, but the protective put offsets much of the loss below the strike. |
What exactly are you giving up?
You gain a downside floor
The put establishes a level below which your losses are substantially limited during the option's life.
You give up some upside
If the stock rises above the call strike, your shares may be called away and you generally do not participate fully above that level.
A collar trades some upside potential for downside certainty.
How to choose the call and put strikes
| Decision | Question to ask yourself | Example |
|---|---|---|
| Call strike | At what price would I be comfortable selling my shares? | If $300 feels like an acceptable exit price, sell the $300 call. |
| Put strike | Below what price do I no longer want to absorb the full decline? | If you want protection below $270, buy the $270 put. |
| Expiration | How long do I need protection? | Choose an expiration that covers the period you are concerned about. |
| Net premium | How much am I paying for protection after the call premium? | Compare put cost against call income before placing the trade. |
Three common collar designs
| Design | Call strike | Put strike | Typical trade-off |
|---|---|---|---|
| Tight collar | Closer to stock price | Closer to stock price | Strong protection, but upside is capped sooner. |
| Wide collar | Farther above stock price | Farther below stock price | More room for stock movement, but weaker downside protection. |
| Low-cost / zero-cost collar | Chosen so call premium roughly funds put | Chosen to match affordable protection | Little or no net premium cost, but strikes may not be ideal otherwise. |
Simple decision guide
| If you believe... | Possible strategy |
|---|---|
| “I want to keep my stock, but I am worried it could fall sharply.” | Collar |
| “I want income and I am comfortable selling my shares higher.” | Covered call |
| “I want income and I am willing to buy more shares lower.” | Cash-secured put |
| “I want maximum downside protection and do not want to cap upside.” | Protective put |
| “I want to collect premium from both stock and reserved cash.” | Covered call + cash-secured put |
Collar vs. covered call + short put
| Feature | Collar | Sell Call + Sell Put |
|---|---|---|
| Main purpose | Protection + controlled upside | Income + willingness to buy more shares |
| Call | Sell | Sell |
| Put | Buy | Sell |
| Downside protection | Yes | No |
| Can increase stock ownership after a decline? | No | Yes, if the short put is assigned |
| Best mental model | Insurance partly funded by rent on shares | Rent on shares + rent on cash |
Important risks and practical points
- Upside is capped: if the stock rises strongly above the call strike, you may be required to sell at the strike.
- Protection is temporary: the put only protects you until its expiration date.
- The put does not eliminate all loss: losses between your stock purchase price and put strike still belong to you.
- Early assignment is possible: the short call can be assigned before expiration.
- Dividends matter: early call assignment risk can increase around ex-dividend dates.
- Taxes can matter: collars, calls, puts, assignment, and holding periods may affect tax treatment.
- Liquidity matters: use contracts with reasonable bid/ask spreads and sufficient trading activity.
- One contract normally represents 100 shares: match your option contracts to the number of shares being protected.
A collar is not automatically “safe.” It reduces a specific downside risk in exchange for cost and capped upside.
The strike prices and expiration determine how much protection you actually receive.
Beginner checklist before placing a collar
| Check | Question |
|---|---|
| ☐ Own enough shares | Do I own 100 shares for each call contract? |
| ☐ Choose exit price | Am I truly willing to sell the stock at the call strike? |
| ☐ Choose protection floor | At what stock price do I want downside protection to begin? |
| ☐ Check expiration | Does the option expiration cover the period I am concerned about? |
| ☐ Calculate net premium | Call premium received minus put premium paid = what net cost or credit? |
| ☐ Review events | Are earnings, dividends, or other major events occurring before expiration? |
| ☐ Review taxes | Could assignment or the collar structure affect my tax plan? |
Key takeaway
Collar = Own Stock + Sell Call + Buy Put
Use a collar when your priority is to keep your stock while limiting downside risk, and you are willing to give up some upside in exchange for that protection.
In the MCD example, selling a $300 call creates income while buying a $270 put creates a downside floor. The call premium can reduce or potentially fully offset the cost of the put.