Collar Options Strategies: Pros, Cons and Examples

A collar options strategy protects stock holdings from significant losses while limiting potential gains. Investors create a collar by owning shares of a stock. They then purchase a put option below the current price and sell a call option above it. The premium collected from selling the call option typically offsets most or all of the cost of the put option. This makes it a low-cost or even zero-cost protection method. This approach appeals to investors who want downside protection for long-term stock holdings without paying substantial insurance premiums.

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What Is a Collar Option?

Options are contracts that give investors the right, but not the obligation, to buy or sell a stock at a predetermined price before a specific expiration date.

Two common types of options include call options and put options.

Call option: A call option grants the holder the right to purchase shares at a set price, known as the strike price. Investors who expect a stock to rise might buy call options to lock in a lower purchase price.

Put option: A put option provides the right to sell shares at the strike price, offering protection if the stock declines. Put buyers essentially purchase insurance against falling stock prices.

There is also a third option: a collar option. A collar option combines these two types with an existing stock position to create a risk management strategy.

The investor first owns shares of a company, before simultaneously executing two transactions. They buy an out-of-the-money put option and sell an out-of-the-money call option. Both options typically expire on the same date and involve the same number of shares.

The put option establishes a floor price below which losses are protected. If the stock falls below the put’s strike price, the investor can sell shares at that higher strike price. By doing this, they limit downside exposure.

The call option caps potential gains. This is because the investor has agreed to sell shares at the strike price if the stock rises above it. The premium received from selling the call offsets the cost of buying the put. This sometimes results in a net-zero cost to establish the position.

Pros and Cons of Using Collar Options

Collar options offer a balanced approach to risk management, but they come with distinct trade-offs. While they provide downside protection at minimal or no cost, they also restrict the upside potential that makes stock ownership attractive in the first place.

Pros	Cons
Limited downside risk: The put option creates a price floor that protects your investment from significant losses if the stock drops sharply.	Capped upside potential: The call option limits your gains if the stock price rises significantly above the call strike price.
Low or zero net cost: The premium collected from selling the call option typically covers most or all of the cost of buying the put option.	Complexity and transaction costs: Establishing and managing a collar requires multiple trades and an understanding of options mechanics.
Maintains stock ownership: You continue holding the underlying shares and can benefit from dividends and moderate price appreciation within the collar range.	Potential opportunity cost: You may miss out on substantial gains during strong bull markets when your stocks would have otherwise soared.
Reduces portfolio volatility: The defined risk parameters make your position less susceptible to dramatic swings in value.	Requires active management: Collars have expiration dates that require you to either close the position, roll the options forward or let them expire, demanding ongoing attention and decision-making.

How a Collar Option Strategy Works

Suppose you own 100 shares of a technology stock. It is currently trading at $50 per share, representing a $5,000 position. To protect against a potential downturn while keeping costs low, you establish a collar by purchasing a put option with a $45 strike price for $150. You simultaneously sell a call option with a $55 strike price for $150. The premiums offset each other, creating a zero-cost collar.

This structure defines clear boundaries for your investment’s value. If the stock falls to $40, the put option allows you to sell shares at $45. This limits your loss to $500, plus any transaction costs. Without the collar, your loss would have been $1,000. Conversely, if the stock rises to $60, you must sell shares at $55 due to the call obligation. This caps your gain at $500.

Between $45 and $55, you participate in normal price movements. At expiration, if the stock trades at $52, both options expire worthless, and you keep the shares with a $200 gain.

How to Execute a Collar Strategy

To set up a collar, you need an options-enabled brokerage account and at least 100 shares of the underlying stock. This is because options contracts typically represent 100-share increments. Start by logging into your options trading platform and navigating to the options trading section for the stock you own.

You can do this one of two ways.

Automatic: Most brokers offer a “collar” or “protective collar” preset strategy that automatically structures the trade. If using this feature, you simply input the strike prices for your put and call options and the expiration date. The platform will show you the net cost or credit for the position.
Manual: If manually constructing the collar, you must execute two separate orders. You must buy a put option with a strike price below the current stock price and sell a call option with a strike price above it.

Select an expiration date that aligns with your investment timeline, commonly ranging from one to six months. Compare the premiums to find strike prices where the call premium offsets the put cost. Then, review the maximum loss and gain scenarios before submitting the orders.

Once you execute your trade, monitor the position. You can then decide whether to close it early, roll the options to new expiration dates or let them expire.

Bottom Line

Collar option strategies let stock owners protect against downside risk while maintaining their positions at little to no up-front cost. By combining protective puts with covered calls, you establish defined price boundaries that limit both losses and gains. This approach can work well for investors seeking to preserve capital during uncertain periods or lock in profits on appreciated stocks without triggering immediate tax consequences from selling shares outright.

Tips for Trading Options and Other Derivatives

If you plan to incorporate options or other derivatives into your portfolio, a financial advisor may be able to help design strategies that fit within your broader goals. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Options, futures and other derivatives have unique pricing components, including time decay, volatility and leverage. Before placing a trade, make sure you understand how factors like expiration dates, strike prices, margin requirements and implied volatility can affect your position.