Executive Hedging and Collars: Zero-Cost Collars, Prepaid Variable Forwards, and the Disclosure Rules

Executives and founders who hold a large block of their company’s stock usually hedge it with one of two structures: a zero-cost collar, which buys a put below the current price and pays for it by selling a call above it, or a prepaid variable forward, which pays the holder cash now in exchange for delivering a variable number of shares later. Both cut the holder’s exposure to a fall in the stock without an outright sale, both are usually arranged privately with a bank, and in the United States both must be reported publicly on Form 4 within two business days.

In short: a collar turns a concentrated stock position into a band: losses below the put strike and gains above the call strike are both handed to the dealer. A prepaid variable forward adds an upfront cash payment, typically most of the shares’ current value, and settles by delivering fewer shares if the price has risen. Companies must disclose whether they allow employees and directors to hedge (Item 407(i) of Regulation S-K, adopted in 2018), insiders must report the trades under Section 16, and the 2022 amendments to Rule 10b5-1 tightened the plans many executives use to trade. Academic studies find that insiders tend to put these hedges on after strong stock performance and, for forwards and collars, before weaker performance.

This is the institutional version of collars explained, which covers the retail mechanics. It describes how the structures and rules work, not whether any person should use them. Nothing here is tax or legal advice.

The misconception: “an executive who hedges has sold”

An executive with a collar still owns the shares, still votes them, and still appears as the owner in the proxy statement’s ownership table. What has changed is the economic exposure: how much the executive’s wealth moves when the stock moves. That gap between legal ownership and economic ownership is exactly why regulators, boards, and investors care. Equity pay is meant to align management with shareholders, and a hedge can quietly undo that alignment while the share count looks unchanged.

The reverse misconception is also common: that hedging is a sign of bad news. Sometimes it is, according to the research below, but the more ordinary reason is concentration. A founder with 80% of net worth in one stock carries risk that no diversified investor would accept, and a collar or forward is a way to reduce it without triggering a sale that might be read as a signal, or without realizing a taxable gain immediately.

How a zero-cost collar is built

A collar on stock you own has three legs: the shares, a long put (the floor), and a short call (the cap). In a zero-cost collar, the strikes are chosen so the call’s premium exactly pays for the put’s premium. For executive hedges the options are usually over-the-counter, written by a dealer bank, European-style, and often longer-dated than listed options (two to three years is common), because the block is too large for listed markets and the tenor needs to match the holder’s plans.

Worked example: a two-year collar on Maple Widgets

Take a hypothetical founder of Maple Widgets Inc. with 1,000,000 shares at $50, a $50 million position. The founder wants a floor at 90% of today’s price. Assume two years to expiry, a 4% interest rate, and a 1% dividend yield. Like most equity options, Maple’s volatility surface has skew: the dealer prices the 45 put at 32% implied volatility and upside calls at 28%.

Pricing with Black-Scholes:

The two-year $45 put costs $4.89 a share.
The call strike that also prices at $4.89 is $61.82. That is the zero-cost cap.
With no skew (both legs at 30%), the zero-cost cap would be $66.05. Skew moves the cap down by more than $4, because the put the founder buys is relatively expensive and the call they sell is relatively cheap.
If the dealer builds in a spread worth 1% of notional (50 cents a share), the cap falls to $59.97. “Zero cost” means no cash changes hands, not that the dealer earns nothing; its margin is embedded in the strikes.

With the cap rounded to $62, the founder’s position at expiry:

Maple at expiry	Unhedged value	Collared value	Collared gain or loss vs $50m
$25	$25.0m	$45.0m	-$5.0m
$35	$35.0m	$45.0m	-$5.0m
$45	$45.0m	$45.0m	-$5.0m
$50	$50.0m	$50.0m	$0
$60	$60.0m	$60.0m	+$10.0m
$70	$70.0m	$62.0m	+$12.0m
$100	$100.0m	$62.0m	+$12.0m

The maximum loss is $5 million (10%), the maximum gain is $12 million (24%), and dividends continue to accrue to the shareholder. The same arithmetic, at retail scale, is in protective puts explained and covered calls explained.

What the collar does to economic ownership

At inception, the put’s delta is -0.27 and the call’s delta is 0.42, so the collared position has a delta of about 0.31: for small moves, the founder now behaves like the owner of roughly 310,000 shares, not 1,000,000. That is the quantity governance analysts care about. Bettis, Bizjak and Lemmon, studying collars and equity swaps, found these transactions “effectively reduce [insiders’] ownership by about 25%, on average.” Our example covers the whole block, so the reduction is larger; the point is that a collar’s effect is measurable in delta terms even though the share count is unchanged.

The dealer’s side

The bank that writes the collar is now long the call and short the put on Maple stock. It delta hedges, which at inception means selling about 690,000 shares’ worth of exposure, usually by short-selling borrowed stock or selling stock the client lends to it, then adjusting as the price moves. Economically, the collar transfers most of the founder’s position to the market through the dealer’s hedge. That is why large collars on thinly traded stocks are hard to arrange, and why banks charge more for them.

Prepaid variable forwards

The SEC describes a prepaid variable forward (PVF) in its 2018 hedging-disclosure release this way: it “obligates the seller to sell, and the counterparty to purchase, a variable number of shares at a specified future maturity date,” with maximum and minimum numbers of shares, and the seller pledges the maximum number of shares at the start. The bank pays most of the value up front.

The usual design has a floor price (often today’s price) and a cap price above it. At maturity:

If the stock is at or below the floor, the holder delivers all the shares.
Between floor and cap, the holder delivers shares worth exactly the floor value, keeping the rest.
Above the cap, the holder delivers shares worth the floor value plus everything above the cap, keeping the gain between floor and cap.

Economically, a PVF is a collar plus a loan: the holder is protected below the floor, shares the upside up to the cap, and receives the present value of that package in cash today.

Worked example: a PVF on the same block

Same founder, same 1,000,000 shares at $50, two years, 4% rate, 1% dividend yield, 30% volatility. Floor $50, cap $65 (130%).

The fair upfront payment equals the present value of what the bank will receive, which is the stock (less dividends the bank will not receive) minus a call struck at the floor plus a call struck at the cap. That works out to $44.17 a share, or 88.3% of today’s price: about $44.2 million in cash today. A cap of 120% would raise the advance to 90.9%; a cap of 150% would lower it to 84.7%. In practice the advance is lower than fair value by the dealer’s margin and financing spread.

Maple at maturity	Shares delivered	Value delivered	Founder keeps
$25	1,000,000	$25.0m	$0
$40	1,000,000	$40.0m	$0
$50	1,000,000	$50.0m	$0
$60	833,333	$50.0m	166,667 shares ($10.0m)
$65	769,231	$50.0m	230,769 shares ($15.0m)
$80	812,500	$65.0m	187,500 shares ($15.0m)
$100	850,000	$85.0m	150,000 shares ($15.0m)

The founder’s upside is capped at $15 a share, the downside below $50 is entirely the bank’s, and $44.2 million arrived two years earlier. Jagolinzer, Matsunaga and Yeung describe PVFs as letting insiders “hedge downside risk, share performance gains, and obtain immediate large-sum cash payments.”

What the evidence says about insider hedging

Three studies are the reference points, all based on insiders’ own SEC filings.

Bettis, Bizjak and Lemmon (“Managerial Ownership, Incentive Contracting, and the Use of Zero-Cost Collars and Equity Swaps by Corporate Insiders,” Journal of Financial and Quantitative Analysis, 2001) searched Forms 3, 4 and 5 from January 1996 to December 1998 and found 87 zero-cost collars and two equity swaps. The transactions “generally involve high-ranking insiders” and reduce effective ownership by about 25% on average, and the authors argued for more transparency. The SEC’s 2018 release notes that the sample companies were much smaller than the S&P 500 average, suggesting collars were more common at smaller firms.
Jagolinzer, Matsunaga and Yeung (“An Analysis of Insiders’ Use of Prepaid Variable Forward Transactions,” Journal of Accounting Research, 2007) found that PVFs covered on average 30% of a sample insider’s firm-specific wealth ($22 million), “substantially larger than a typical open-market sale.” PVFs “systematically follow strong firm performance and precede degraded stock and earnings performance,” and the authors conclude that insiders use them “to diversify firm-specific holdings in anticipation of performance declines.”
Bettis, Bizjak and Kalpathy (“Why Do Insiders Hedge Their Ownership? An Empirical Examination,” Financial Management, 2015) compared instruments and found the evidence on forwards and collars “more consistent with the strategic timing of transactions by insiders,” while exchange funds appeared to be used mainly for diversification and tax reasons.

The SEC, summarizing this literature in 2018, concluded the evidence was mixed on whether hedging instruments are a reasonable response to agency problems or a sign of poorly designed pay.

The rules

Section 16: reporting within two business days

Directors, officers, and 10% holders are Section 16 insiders. Under Exchange Act Section 16(a), as the SEC’s 2018 release summarizes, transactions in derivative securities that derive their value from company equity, including options, equity swaps, and other instruments, must be reported on Form 4 within two business days. The SEC has said forward sales contracts such as PVFs are derivative securities transactions subject to Section 16(a), and equity swaps are reported with transaction code K. Shares pledged as collateral, as in a PVF, must also appear in the proxy ownership table under Item 403(b) of Regulation S-K.

Two other parts of Section 16 shape how hedges are built:

Section 16(c) bars insiders from short sales of their company’s stock, which is why insiders hedge with options and forwards rather than shorting.
Section 16(b) lets the company recover “short-swing” profits from any purchase and sale (or sale and purchase) within six months. Writing a call is treated as a “put equivalent position” under Rule 16a-1(h), so the timing of collar legs relative to other trades is checked carefully.

Item 407(i): the hedging policy disclosure (2018)

Section 955 of the Dodd-Frank Act added Section 14(j) to the Exchange Act, and on December 18, 2018 the SEC implemented it by adopting Item 407(i) of Regulation S-K (Release No. 33-10593). Companies must describe in their proxy statement any practices or policies regarding the ability of employees (including officers) and directors to “purchase financial instruments (including prepaid variable forward contracts, equity swaps, collars, and exchange funds), or otherwise engage in transactions” that hedge or offset a decrease in the market value of company equity. The rule took effect March 8, 2019; companies other than smaller reporting and emerging growth companies had to comply for fiscal years beginning on or after July 1, 2019, and those smaller companies from July 1, 2020.

Item 407(i) requires disclosure, not prohibition. A company with no policy must say so or say that hedging is generally permitted. In practice most large companies restrict or ban hedging: the SEC’s release cites a 2017 analysis in which 98% of a random sample of S&P 500 companies disclosed hedging policies for named executive officers (71% for S&P SmallCap 600 companies), and an industry study finding that 92% of the 250 largest S&P 500 companies prohibited executive hedging in 2015.

Rule 10b5-1: the 2022 amendments

Most executives trade, and often hedge, under Rule 10b5-1 plans: written instructions adopted when the insider has no material nonpublic information, which provide an affirmative defense against insider trading claims. The rule has long denied the defense to anyone who enters into or alters “a corresponding or hedging transaction or position” with respect to the planned trades, which the SEC explains was designed to stop insiders from setting up both sides of a hedge and then cancelling the unfavorable side.

On December 14, 2022, the SEC adopted amendments (Release No. 33-11138), effective February 27, 2023. According to the SEC’s fact sheet, they added:

A cooling-off period for directors and officers of the later of 90 days after adopting or modifying a plan or two business days after the issuer discloses results for the quarter in which the plan was adopted, capped at 120 days. Others (except issuers) wait 30 days.
A certification by directors and officers, when adopting a plan, that they are not aware of material nonpublic information and are acting in good faith.
Limits on overlapping plans and on single-trade plans (one per 12 months for anyone other than issuers), plus a requirement that everyone act in good faith throughout the plan.
New issuer disclosures: quarterly reporting of directors’ and officers’ plan adoptions and terminations (Item 408(a)), annual disclosure of insider trading policies (Item 408(b)), and tabular disclosure of option grants made close to the release of material nonpublic information.
A Form 4 checkbox for trades intended to satisfy Rule 10b5-1(c), and reporting of bona fide gifts on Form 4, from April 1, 2023.

The enforcement backdrop changed at the same time. In June 2024 a jury convicted Terren Peizer, the former chairman of Ontrak, in what the Justice Department called its first insider trading prosecution based exclusively on the use of a trading plan; prosecutors said he avoided more than $12.5 million in losses, and he was later sentenced to 42 months in prison, according to the US Attorney’s Office for the Central District of California.

Taxes: why these structures look the way they do

US tax law shapes the design. Since 1997, Section 1259 of the Internal Revenue Code treats certain hedges that eliminate substantially all risk and reward of an appreciated position as constructive sales, triggering gain. A collar with a narrow band, or a forward with no upside, can fall inside that rule; a band wide enough to leave meaningful risk and reward is generally used to stay outside it. For PVFs, the IRS’s Revenue Ruling 2003-7 concluded that a particular PVF, with the shares pledged and the holder free to deliver cash or other shares, was neither a current sale nor a constructive sale, so tax is deferred to settlement. Collars on stock you own can also be straddles under Section 1092, which can defer losses and affect holding periods (an overview is in how options are taxed in the US).

The leading recent case shows the limits. Monster Worldwide founder Andrew McKelvey entered PVFs on 6.5 million Monster shares with two banks in September 2007, receiving upfront payments totaling about $193.6 million, then paid $11.7 million in July 2008 to extend them; he died in November 2008. The Tax Court first held the extension was not taxable (148 T.C. No. 13, 2017). The Second Circuit reversed in September 2018 (906 F.3d 26), holding that the extended contracts were constructive sales of the stock under Section 1259, and sent back a new IRS argument under Section 1234A. On remand, the Tax Court held in 2023 (161 T.C. No. 9) that the extension also terminated the original obligations, producing about $71.7 million of short-term capital gain under Section 1234A, on top of long-term gain from the constructive sale that the parties agreed at about $102.4 million. Modifying a PVF can be a taxable event.

How professionals run the process

Policy check first. Counsel confirms the company’s hedging policy (now disclosed under Item 407(i)) and any pledging limits before a dealer is engaged. Many large companies prohibit these trades outright.
Window and plan. Hedges are timed for open trading windows or placed under a Rule 10b5-1 plan, with the cooling-off period and certification built into the timeline.
Structure for tax and Section 16. Strikes, caps, and tenors are set with Section 1259, Section 1092, and short-swing matching in mind, and the Form 4 is prepared before execution so it can be filed within two business days.
Dealer hedging. The bank’s delta hedge is sized against the stock’s liquidity; for large blocks it may sell over weeks, and the price the client gets reflects that execution risk.
Disclosure and optics. Because a Form 4 is public, the market will see the hedge. Investors and proxy advisers read hedging as a weakening of alignment, and the research above gives them reason to.

What can go wrong

The cap binds. If the stock triples, the collar or PVF holder keeps only the band. The founder in our example would forgo $38 million above the $62 cap at $100.
Counterparty and collateral terms. The dealer holds pledged shares. Corporate events (mergers, special dividends, spin-offs) trigger adjustment or early termination clauses that the holder must understand.
Tax recharacterization. A structure that is too tight, or a later modification, can create a constructive sale or a taxable exchange, as McKelvey’s estate learned.
Legal exposure from timing. Hedging while aware of material nonpublic information is insider trading regardless of the instrument, and the 2022 amendments and the Peizer case show regulators examining plan timing closely.
Governance fallout. Hedging that violates company policy, or that investors see as undermining pay, can lead to clawbacks, votes against directors, or forced unwinds.

The short version

Executives hedge concentrated stock mainly with zero-cost collars (long put, short call, no net premium) and prepaid variable forwards (a collar plus cash up front, settled in a variable number of shares). In our example, a two-year 45/61.82 zero-cost collar on 1,000,000 Maple Widgets shares cuts the holder’s delta from 1.0 to about 0.31, and a PVF with a $50 floor and $65 cap pays about 88% of the stock’s value today. Insiders report these trades on Form 4 within two business days; larger companies have had to disclose their hedging policies under Item 407(i) for fiscal years beginning on or after July 1, 2019; and the 2022 Rule 10b5-1 amendments added cooling-off periods, certifications, and plan limits. Research by Bettis, Bizjak and Lemmon, Jagolinzer, Matsunaga and Yeung, and Bettis, Bizjak and Kalpathy finds these hedges often follow strong performance and, for forwards and collars, tend to precede weaker results.