Collar Strategy
Collar Strategy
Options strategy combining a protective put (downside protection) with a covered call (upside limitation) on stock you already own. Typically structured to be zero-cost or low-cost, where the premium received from selling the call offsets the cost of buying the put. Caps both potential gains (above call strike) and potential losses (below put strike), creating a defined profit/loss range. Commonly used by investors with concentrated stock positions (executives, founders) who want to protect gains without triggering immediate capital gains taxes.
Sarah, a tech executive, owns 10,000 shares of her company stock trading at $100 per share (total value: $1M). To protect against a market downturn while avoiding capital gains taxes, she implements a collar: (1) Buys 100 put options with a $95 strike for $3 per share ($30,000 total), providing downside protection below $95; (2) Sells 100 call options with a $110 strike for $3 per share ($30,000 total premium collected), capping upside above $110. The strategy costs zero (premium received = premium paid), limits losses to 5% ($95 floor), but also caps gains at 10% ($110 ceiling). If the stock falls to $80, Sarah can exercise her puts and sell at $95. If the stock rises to $130, her shares will be called away at $110.
Students often confuse which option is bought vs sold (you BUY the put for protection, SELL the call for income). Another error is miscalculating the profit/loss limits (max loss = stock price minus put strike minus net premium; max gain = call strike minus stock price minus net premium). Many forget the collar only works if you already own the stock (covered position). Some incorrectly think collars are always zero-cost, but they can have a small net debit or credit depending on strike prices chosen. Finally, students may not recognize that collars sacrifice unlimited upside potential in exchange for downside protection.
How This Is Tested
- Identifying when a collar strategy is appropriate based on client situation (concentrated position, downside protection needed)
- Understanding the components of a collar (long stock, long put, short call) and what each contributes
- Calculating maximum gain and maximum loss for collar positions at various stock prices
- Determining whether a collar is zero-cost based on premium paid vs premium received
- Recognizing the tax efficiency advantage of collars (defer capital gains) versus selling stock outright
Example Exam Questions
Test your understanding with these practice questions. Select an answer to see the explanation.
Mark, a 52-year-old CFO, owns 20,000 shares of his company's stock currently trading at $80 per share, representing 70% of his $2.3M net worth. He has a very low cost basis ($15 per share) and is concerned about a potential market correction, but he doesn't want to sell and trigger $1.3M in capital gains. His investment objective is capital preservation with some growth. Which strategy would be most appropriate?
B is correct. A collar strategy is ideal for Mark's situation: he gets downside protection through the put (addressing his market correction concern), funds the put purchase by selling calls (zero-cost or low-cost structure), maintains his stock ownership (deferring capital gains taxes), and still allows some upside participation (up to the call strike). This balances his capital preservation objective with tax efficiency and addresses the concentration risk concern.
A would trigger $1.3M in immediate capital gains taxes (20% federal long-term capital gains = $260K, plus state taxes and potential 3.8% net investment income tax), which he wants to avoid. While diversification is eventually needed, the tax hit makes this unsuitable for immediate action. C (protective puts only) provides full downside protection and unlimited upside, but costs significant premium (likely $60K-$100K for 20,000 shares), which is expensive and doesn't align with wanting a low-cost solution. D (covered calls only) generates income but provides NO downside protection beyond the premium collected, leaving Mark fully exposed to the market correction he fears.
The Series 65 exam tests your ability to recommend appropriate options strategies based on client circumstances. Collar strategies are particularly important for executives with concentrated stock positions who face the dual challenges of concentration risk and tax efficiency. You must understand when collars are suitable (concentrated position + downside concerns + tax deferral needs) versus when other strategies are better (protective puts for unlimited upside, outright sale for full diversification, covered calls for income generation only).
What are the three components of a collar strategy?
B is correct. A collar strategy consists of three components: (1) Long stock (you own the underlying shares), (2) Long put (you buy a put option for downside protection), and (3) Short call (you sell a call option to generate premium income that offsets the put cost). This combination creates a defined profit/loss range.
A reverses the options positions: long call and short put would create a synthetic long stock position with very different risk/reward characteristics than a collar. C describes a conversion strategy (short stock with long put and long call), which is not a collar and is used for arbitrage. D would create unlimited downside risk from the short put (obligation to buy more shares), which defeats the purpose of a protective collar.
The Series 65 exam frequently tests your knowledge of options strategy components. You must know that a collar requires owning the stock (long), buying a put for protection (long), and selling a call for income (short). Confusing the positions (buying vs selling calls/puts) changes the entire strategy and risk profile. Understanding the exact structure is critical for evaluating suitability and explaining strategies to clients.
Master Investment Vehicles Concepts
CertFuel's spaced repetition system helps you retain key terms like Collar Strategy and 500+ other exam concepts. Start practicing for free.
Access Free BetaAn investor owns 100 shares of XYZ stock purchased at $50 per share. She implements a collar by buying a put with a $48 strike for $2 per share and selling a call with a $55 strike for $2 per share (zero net cost). If XYZ stock is trading at $42 at expiration, what is her profit or loss per share?
A is correct. Calculate the collar profit/loss:
1. Stock declined from $50 (purchase) to $42 (current) = $8 loss per share
2. Put option with $48 strike is in-the-money. Exercise the put to sell at $48, limiting the stock loss to $50 - $48 = $2 per share
3. Call option with $55 strike expires worthless (stock at $42 is below strike)
4. Net premium = $0 (received $2 from call, paid $2 for put)
5. Total loss = $2 per share (the difference between purchase price $50 and put strike $48)
The protective put limits losses below $48, so even though the stock fell to $42, she can exercise her put and sell at $48, limiting her loss to $2 per share.
B ($6 loss) incorrectly ignores the put protection and calculates stock price ($42) minus put strike ($48) = $6. C ($8 loss) calculates the unprotected stock loss ($50 - $42 = $8) without recognizing the put limits the loss. D ($10 loss) incorrectly adds the premium costs to the stock loss.
The Series 65 exam tests your ability to calculate collar profit/loss at various stock prices. Key principle: the put establishes a floor (maximum loss = purchase price minus put strike minus net premium), while the call establishes a ceiling (maximum gain = call strike minus purchase price minus net premium). When the stock falls below the put strike, the put limits your loss. When the stock rises above the call strike, your shares get called away. Understanding these calculations is essential for evaluating collar effectiveness and explaining outcomes to clients.
All of the following statements about collar strategies are accurate EXCEPT
C is correct (the EXCEPT answer). This statement is FALSE. A collar does NOT guarantee no losses. The put only protects against losses BELOW the put strike price. The investor is still exposed to losses between the current stock price and the put strike. For example, if you own stock at $100, buy a $95 put, and the stock falls to $95, you have a $5 loss per share (the put doesn't provide value until the stock falls below $95). The put provides a floor, not complete elimination of losses.
A is accurate: collars cap both upside (at the call strike) and downside (at the put strike), creating a defined profit/loss range or "collar" around the current stock price. B is accurate: zero-cost collars are common, structured so the call premium received exactly offsets the put premium paid (though the strikes must be chosen carefully to achieve this balance). D is accurate: collars are frequently used by executives and founders with large, low-cost-basis stock holdings who want downside protection without selling (which would trigger capital gains taxes). The collar defers the tax liability while providing protection.
The Series 65 exam tests your understanding that collars provide LIMITED downside protection (floor at put strike, not complete protection) and LIMITED upside participation (ceiling at call strike). You must recognize what collars can and cannot do. They reduce risk but don't eliminate it completely. They allow some upside but cap unlimited gains. Understanding these trade-offs is critical for suitability analysis and managing client expectations about collar outcomes.
An investor owns 1,000 shares of ABC stock trading at $60 per share. She implements a collar by buying 10 put contracts with a $55 strike for $2 per share and selling 10 call contracts with a $70 strike for $3 per share. Which of the following statements are accurate?
1. The collar generated a net credit of $1 per share ($1,000 total)
2. The maximum potential loss is $5 per share ($5,000 total)
3. The maximum potential gain is $10 per share ($10,000 total)
4. The investor maintains unlimited upside potential above $70
B is correct. Statements 1 and 3 are accurate.
Statement 1 is TRUE: Net premium = Call premium received ($3) - Put premium paid ($2) = $1 net credit per share × 1,000 shares = $1,000 total credit. This collar generated income rather than costing money.
Statement 2 is FALSE: The maximum potential loss is $4 per share, NOT $5. Calculate: Stock price ($60) - Put strike ($55) = $5 stock decline, minus $1 net credit received = $4 net loss per share ($4,000 total). The net credit from the collar reduces the maximum loss from $5 to $4. The statement claiming $5 loss ignores the $1 premium credit.
Statement 3 is TRUE: Maximum gain on the stock position = Call strike ($70) - Stock price ($60) = $10 per share appreciation, plus the $1 net credit = $11 total gain. However, if the statement refers only to the stock price gain (excluding premium), it would be $10. The stock can appreciate $10 (from $60 to $70) before shares are called away.
Statement 4 is FALSE: The investor does NOT maintain unlimited upside. By selling the call at $70 strike, she caps her upside at $70. If the stock rises to $100, her shares will be called away at $70, limiting her stock gain to $10 per share (plus the $1 credit = $11 total). This is the key trade-off of a collar: sacrifice unlimited upside for downside protection.
Only statements 1 and 3 are accurate.
The Series 65 exam tests your understanding of collar mechanics, including net premium calculations (credit vs debit), maximum gain/loss calculations, and the upside/downside trade-offs. You must recognize that collars cap both upside (at call strike) and downside (at put strike), and that the net premium affects the overall profit/loss. Understanding these mechanics is essential for evaluating whether a collar is zero-cost, generates credit, or costs premium, and for explaining the defined risk/reward range to clients.
💡 Memory Aid
Think of a collar on a dog: it creates a defined boundary (the dog can only go so far up or down). A collar strategy creates a profit/loss collar around your stock position. You BUY the put (floor/protection - like the bottom of the collar), SELL the call (ceiling/cap - like the top of the collar), creating a defined range. Remember: Put = Protection (downside floor), Call = Cap (upside ceiling). Typically zero-cost because call premium offsets put cost.
Related Concepts
This term is part of this cluster:
More in Options Strategies
Where This Appears on the Exam
This term is tested in the following Series 65 exam topics: