Collar Strategy
A collar strategy is an options position established by owning shares of stock, selling an out-of-the-money call, and buying an out-of-the-money put, creating a protective range that caps both the upside gain and downside loss.
The collar is one of the most practical risk-management tools available to investors who hold significant long stock positions and want to protect against a large decline without selling the shares outright. It is constructed in three parts: the existing long stock position, a short out-of-the-money call (which generates income), and a long out-of-the-money put (which provides downside protection). The premium collected from the call partially or fully offsets the cost of the put, making this a low-cost or even zero-cost hedge in many cases.
For example, suppose an investor owns 500 shares of Johnson & Johnson (JNJ) at $150 per share and wants to protect against a decline below $140 while keeping downside insurance costs low. They might sell a $160 call for $2.50 and buy a $140 put for $2.50, creating a zero-cost collar. The trade-off: if JNJ rallies past $160, gains are capped. If it falls below $140, losses beyond that level are covered by the long put.
The collar is commonly used by corporate insiders, executives with large equity grants, and institutional investors managing concentrated positions. Because of the tax implications of selling appreciated stock — particularly in cases involving long-term capital gains — collars provide economic downside protection without triggering a taxable disposition. However, the IRS has scrutinized certain collar structures that behave economically like a sale; investors should consult qualified tax professionals for guidance on specific situations.
The cost structure of a collar depends heavily on the implied volatility skew. In U.S. equity markets, out-of-the-money puts typically carry higher implied volatility than out-of-the-money calls — a phenomenon known as volatility skew. This means that put protection often costs more than the call premium received, particularly in bearish or uncertain market environments. Adjusting the strikes can widen or narrow the protected range to balance cost and coverage.
From an options mechanics standpoint, the short call in a collar is covered by the underlying stock position, so it does not require the same margin treatment as a naked call. At U.S. broker-dealers regulated by FINRA, covered calls held alongside long stock do not generate additional margin requirements beyond the stock position itself. The OCC clears both the call and put legs as separate contracts, each subject to standard settlement procedures.