Options - Collar

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A collar is an options strategy of holding an underlying asset, writing a call option and purchasing a put option on the same asset (of equivalent quantities). Usually, both options are out of the money when the strategy is created, which means the strike prices are such that they wouldn't be exercised.

The strategy is used mainly to "protect" the gains on the asset, rather than to earn excess profits. By entering into a collar, the puts protect the investor from a decrease in stock prices, while the out of the money calls allow the investor to earn a bit more profit.

For example an investor holds 100 stocks ABC which currently trades at $100. Buying a put option with a strike price of $95, and selling a call option with a strike price of $105 would create a collar. The strategy ensures that the investor would be able to sell his stocks for at least $95, while his gains are capped to $5 per stock ($105-$100).

The alternative to a collar would be to sell the underlying asset -- in which case the investor forgoes both the upside and the downside.

Payoff

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