Collar

Overview

The Collar is the ultimate defensive strategy for long-term investors. It is essentially a way to buy "Insurance" (the put) without actually paying for it. You pay for the insurance by "renting out" your upside (the call).

By placing your stock between a long put and a short call, you create a narrow corridor of risk. You can't lose too much, but you can't win too much either.

[!NOTE] This is often called a Zero-Cost Collar if the premium you collect from selling the call is equal to the price you pay for the put.

The Setup

A Collar consists of:

1. Long Stock: 100 Shares of the underlying.
2. Protective Put: Buy 1 Put (OTM) at Strike $K_1$.
3. Covered Call: Sell 1 Call (OTM) at Strike $K_2$.

Mechanics: The "Price Corridor"

• The Floor: If the stock crashes, your long put gains value, offsetting the loss on your shares. Your loss is "capped" at $K_1$.
• The Ceiling: If the stock rallies, your short call will be exercised. You'll be forced to sell your shares at $K_2$, even if the stock is at $1,000.
• The Comfort Zone: Between the two strikes, your stock behaves normally, but your overall volatility is dampened.

Payoff and Break-even

Max Profit

The distance from your purchase price to the call strike, adjusted for any net credit/debit.

$$\text{Max Profit} = (K_2 - S_0) + \text{Net Premium}$$

Max Loss

The distance from your purchase price down to the put strike.

$$\text{Max Loss} = (S_0 - K_1) - \text{Net Premium}$$

The "Lower Volatility" Greeks

The Collar is designed to neutralize almost every major risk except for the movement of the stock itself within the corridor.

1. Delta: Reduced Exposure

Standalone stock has a Delta of 1.00. A collar reduces that Delta significantly. You are essentially "controlling" fewer shares' worth of risk while still holding the position.

2. Vega: Skew Neutral

Because you are long one option and short another, changes in Implied Volatility tend to cancel each other out. This makes the trade very stable during market turbulence.

3. Theta: The Wash

Like Vega, the time decay of the short call helps you, while the time decay of the long put hurts you. If structured correctly, they wash each other out, meaning time passing has a neutral effect on your P&L.

When to Use?

• Holding for Gains: You have a large profit in a stock and want to protect it through a rocky period without selling the shares.
• Conservative Income: You want to sell covered calls but are terrified of a sudden 20% drop.
• Margin Management: Using a collar can lower the margin requirement for a stock position because the risk is defined.

Checklist for Entry

• Is my "Floor" ($K_1$) high enough to prevent a catastrophic loss?
• Is my "Ceiling" ($K_2$) high enough that I won't be angry if I have to sell the stock?
• Is the net cost of the trade close to zero?

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The Collar is widely used by corporate executives who are "over-exposed" to their own company stock.

If an executive owns $10 Million in shares but is forbidden from selling them due to SEC rules, they can use a collar to effectively "lock in" their net worth. Even if the company collapses, their equity is protected at the put strike.