Collar
IntermediateA collar is an options strategy that protects an existing holding against large losses by buying a put option and paying for it, partly or fully, by selling a call option, which limits potential gains.
A collar sets both a floor and a ceiling on the value of an investment. The put option sets the floor, giving the right to sell at a set price if the share falls. The call option sets the ceiling, obliging the investor to sell at a set price if the share rises above it.
For example, an investor owns shares trading at 50. They buy a put option with an exercise price of 45 and sell a call option with an exercise price of 60. If the share price falls to 35, the put lets them sell at 45, limiting the loss. If the share price rises to 70, they must sell at 60, giving up gains above that level. Between 45 and 60, the investor simply gains or loses along with the share.
If the premium received from selling the call equals the cost of buying the put, the collar costs nothing upfront, and is called a zero-cost collar.
Collars are used by investors who want to protect large gains, by executives holding concentrated positions in their company's shares, and by companies hedging commodity prices or currency risk. The trade-off is giving up potential upside in exchange for protection.
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