What is a collar?
In one line: A collar is owning 100 shares, selling a call above the price and buying a put below it, so the premium from the call helps pay for the put, the put sets a floor, and the call caps the gain.
How it works
Start with a Covered call: 100 shares plus a short Call option above the price. Now buy a Put option below the price. That's a collar.
The put is insurance. Below its strike, your shares can't lose more. The call's premium pays for some or all of the put. In return, the call caps your gain above its strike.
So a collar draws two lines around your shares:
- A floor at the put strike. Your max loss is known.
- A ceiling at the call strike. Your max gain is known.
Between the lines, the shares behave normally. The cost is the difference between what the put costs and what the call pays. If they match, it's a "zero-cost collar". If the put costs more, you pay the difference.
Collars matter to the wheel strategy because the wheel's big risk is a stock that keeps falling after assignment. A collar is one way to put a floor under that. The next example shows what the floor costs.
An example (hypothetical)
An illustration, not a trade idea. You own 100 shares of made-up stock XYZ at $50. You sell a 60-day $55 call for $1.20 and buy a 60-day $45 put for $1.50. Net cost: $0.30, or $30.
| XYZ at expiry | Shares | Call | Put | Total result |
|---|---|---|---|---|
| $65 | +$1,500 | Called away at $55: gain stops at +$500 | Expires | +$500 − $30 = +$470 (the cap) |
| $55 | +$500 | Expires or assigned at the strike | Expires | +$470 |
| $50 | $0 | Expires | Expires | −$30 (the collar's cost) |
| $45 | −$500 | Expires | Expires, at the money | −$530 |
| $35 | −$1,500 | Expires | Put pays +$1,000 | −$530 (the floor) |
Look at the two bottom rows. At $35, a plain shareholder is down $1,500. The collar holds the loss at $530. That's the floor working. But at $50, where nothing happened, you're down $30, and at $65 you gave up $1,030 of gains. The floor was paid for with the ceiling.
Why it matters for sellers
A collar turns an open-ended risk into a boxed one. That's valuable when you're holding assigned shares you can't afford to see fall further, or around an event you can't skip. The trade-offs:
- The put costs money every cycle. Buying protection repeatedly is a drag. Many people collar only around known risks, not always.
- Tight collars cap tightly. A floor close to the price needs a call close to the price to pay for it, and that call gets assigned often.
- Taxes and dividends. Collars can affect holding periods and dividend treatment in some accounts. Check with your broker or tax adviser.
A practical read: if you find yourself wanting a collar on every position, the positions may be too big. A floor is cheaper when the risk fits the account in the first place.
Questions
What is a zero-cost collar?
A collar where the call premium exactly pays for the put. It costs nothing to open, but it still costs the upside above the call strike. Zero-cost is rarely exactly zero; the bid-ask spread usually leaves a few dollars either way.
Does a collar protect against a stock crash?
Below the put strike, yes: the put pays what the shares lose. Between the stock price and the put strike, you still take the loss. In the example, a crash to $35 costs $530, not $1,500.
When do people use a collar?
Around a known risk on shares they want to keep, like an earnings report, or after assignment on a stock they can't afford to see fall much further. It's protection you pay for, not a way to add premium.
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