Collars Explained: Capping Losses and Gains With a Put and a Call

A collar is a position where you own shares, buy a put below the current price, and sell a call above it, usually with the same expiry. The put sets a floor under your losses, the call sets a ceiling on your gains, and the premium from the call pays for some or all of the put.

In short: a collar = long 100 shares + long 1 out-of-the-money put + short 1 out-of-the-money call. It is a protective put and a covered call on the same shares at once. The maximum loss is (share cost minus put strike, adjusted for the net premium) x 100; the maximum gain is (call strike minus share cost, adjusted for the net premium) x 100. A “zero-cost” collar has no net premium up front, but it is not free: you give up the upside above the call strike in exchange for the floor.

How the position is built

Three legs, usually with the same expiry:

Leg	Action	Role
Stock	Own 100 shares	The position being hedged
Put, strike below the price	Buy	Floor: the right to sell at the put strike
Call, strike above the price	Sell	Ceiling: the obligation to sell at the call strike; premium offsets the put’s cost

How far apart the strikes are determines how much of the stock’s movement you keep. A narrow collar (strikes close to the current price) leaves you with very little risk and very little upside. A wide collar leaves more of both.

A worked example

Hypothetical Maple Widgets Inc. trades at $50. You own 100 shares bought at $50. With 90 days to expiry, using illustrative prices:

Buy one $45 put for $1.85.
Sell one $55 call for $2.10.
Net premium: $2.10 minus $1.85 = $0.25 credit, or $25 received.

Results:

Maximum loss: ($50 minus $45 minus $0.25) x 100 = $475, at $45 or below.
Maximum gain: ($55 minus $50 + $0.25) x 100 = $525, at $55 or above.
Breakeven: $50 minus $0.25 = $49.75.

Payoff at expiry, compared with shares alone and a protective put alone

Price at expiry	Shares only	Shares + $45 put	Collar (shares + $45 put + short $55 call)
$30	minus $2,000	minus $685	minus $475
$40	minus $1,000	minus $685	minus $475
$45	minus $500	minus $685	minus $475
$49.75	minus $25	minus $210	$0 (breakeven)
$50	$0	minus $185	+$25
$55	+$500	+$315	+$525
$60	+$1,000	+$815	+$525
$70	+$2,000	+$1,815	+$525

The collar beats the protective put everywhere up to the call strike, because the call premium paid for the put. Above $55, the collar stops gaining while the other two keep going. At $70, the cost of the ceiling is clear: $525 instead of $2,000 for shares alone.

The illustrative call is priced slightly higher than the equally distant put here, which is why the example produces a small credit. On many real stocks and indexes, out-of-the-money puts trade at higher implied volatility than equally distant calls (the volatility skew), so a collar with symmetric strikes often costs a small debit instead. How implied volatility varies by strike is covered in implied volatility explained.

Max gain, max loss, and breakeven

With a net debit D or net credit C per share:

Maximum loss: (share cost minus put strike + D) x 100, or (share cost minus put strike minus C) x 100.
Maximum gain: (call strike minus share cost minus D) x 100, or (call strike minus share cost + C) x 100.
Breakeven: share cost + D, or share cost minus C.

How the strikes change the trade-off

Using illustrative 90-day prices for the same stock, three collars on shares bought at $50:

Collar	Put bought	Call sold	Net premium	Max loss	Max gain	Breakeven
Narrow (47.50/52.50)	$2.70	$2.95	$0.25 credit	$225	$275	$49.75
Middle (45/55)	$1.85	$2.10	$0.25 credit	$475	$525	$49.75
Wide (40/60)	$0.60	$1.05	$0.45 credit	$955	$1,045	$49.55

A narrow collar comes close to converting the shares into something like cash for the period: very little can be lost or gained. A wide collar leaves most of the stock’s movement in place and protects only against large falls. The arithmetic is the same in each case: max loss and max gain add up to the distance between the strikes, times 100.

What “zero-cost” means

A zero-cost collar chooses strikes so that the call premium equals the put premium. It requires no cash up front, but the cost is real: it is the gains above the call strike that you have agreed to hand over. Whether that is a good or bad exchange depends on how the options are priced, which no label settles.

Researchers have made this point directly. Roni Israelov and Matthew Klein (“Risk and Return of Equity Index Collar Strategies,” The Journal of Alternative Investments, Summer 2016) argued that a collar’s lack of an upfront outlay “reveals absolutely nothing” about its investment merits. A collar mechanically has less equity exposure than the index, so it collects less of the equity risk premium; and because index puts have tended to be priced richer than calls, buying the put and selling the call has, on balance, tended to cost the collar holder value over time. Their study used the Cboe S&P 500 95-110 Collar Index (CLL), which holds the S&P 500, buys a three-month put struck at about 95% of the index, and sells a one-month call struck at about 110%. Cboe’s methodology lists a base date of June 30, 1986 and a launch date of September 4, 2008; values before launch are back-tested.

How time decay and volatility affect it

A collar holds one long option and one short option, so much of the time decay and volatility exposure offsets.

Time decay: the long put loses time value and the short call loses time value. When both are similarly out of the money, the effects roughly cancel. When the stock moves toward the put, the put’s decay dominates (hurting you); when it moves toward the call, the call’s decay dominates (helping you).
Volatility: rising implied volatility raises both options’ prices. The net effect is usually small and depends on which option is closer to the money and on the skew.
Delta: the shares contribute delta 1.00 per share; the long put and short call both subtract delta. Between the strikes, the collar moves less than the stock. Beyond either strike, its net delta heads toward zero: it stops responding to further moves.

The sensitivities are explained in option Greeks explained.

Assignment and early exercise

The short call can be assigned early. US equity options are American-style. The usual trigger is an upcoming ex-dividend date when the call is in the money and its remaining time value is smaller than the dividend. If assigned, you sell your shares at $55 and are left holding the put by itself.
The long put is yours to exercise. You’ll never be assigned on it, but if it ends in the money at expiry, the Options Clearing Corporation’s exercise-by-exception procedure will exercise it unless you instruct otherwise ($0.01 or more in the money; your broker may use a different threshold), selling your shares at $45.
At expiry, the shares are likely to leave if the stock is above the call strike or below the put strike. Only between the strikes do both options expire and the shares stay. The full process is in how exercise and assignment work.

Tax notes (overview only)

US: under IRS Publication 550, an actively traded stock and an option on it can form a straddle, and a collar on shares you own will typically meet that definition. The straddle rules can defer losses and affect holding periods. Publication 550 also has constructive-sale rules for appreciated positions; whether a given collar is affected depends on its terms. See how options are taxed in the US.
Canada: premiums paid and received generally affect your gain or loss on the options and the shares, and treatment depends on whether you report on capital or income account.

This is not tax or legal advice.

What can go wrong

Giving up a large rally. A takeover bid or strong earnings above the call strike benefits the buyer of your call, not you.
The floor is lower than it looks. With a $45 put, you can still lose $475 before the protection is fully in place.
Protection expires. A collar covers one period. Renewing it means new strikes, new prices, and possibly a higher floor cost after a decline, when implied volatility tends to be high.
Early assignment on the short call can take your shares, and the dividend, at an inconvenient time, leaving a lone long put.
Tax surprises from the straddle rules or an unintended sale on assignment.
Liquidity and costs. Two option legs mean two bid-ask spreads; on thinly traded stocks this can be significant.

The short version

A collar wraps owned shares between a long put and a short call. You know your worst and best case for the period, often for little or no upfront premium. The trade-off is a capped upside, and “zero-cost” refers only to cash today, not to what you give up. Both options can lead to your shares being sold at expiry, and the short call can be assigned early.