Series 7: 5.3.2. Collars

5.3.2. Collars

A collar is a type of options strategy that is used to protect a long position in a stock that has already achieved unrealized gains. A collar is a combination of a covered call and a protective put. A covered call occurs when an investor has a long stock position and then writes a call option on that stock to receive income. An investor buys a protective put when she has a long stock position and buys a put on the same stock to protect against a decline in the stock’s market price.

An investor enters into a collar if they wish to protect significant gains in a stock and are uncertain about whether the stock’s price will go up or down. Someone who chooses a collar option strategy must be willing to part with the stock on which they are writing and purchasing the options.

When a collar is created, an investor purchases out-of-the-money put options so they can sell the stock at the strike price if the stock’s price declines. This put option locks in the investor’s gains. The investor also writes out-of-the-money call options on the same stock to help pay for the put options. But these call options cap the upside potential of the underlying stock because once the options go into the money, they will likely be exercised at the strike price. When that occurs, the