What Is a Collar Strategy in Options Trading?

Are you also looking for a way to trade in futures and options, but without paying a high premium? Well, then you are not the only one. Many traders look for this option or strategy to ensure that they earn well and at a lower cost. But the question is, which is the best option trading strategy for this?

Well, while you may come across other choices too, the best one to go for is the collar strategy. The collar option strategy allows you to enjoy a higher level of protection without paying a high premium.

But the question here is what an option strategy is in real terms and how you can actually use it while trading? Well, if you are also eager to know this, then read the guide over here to explore all the details you need. 

What Is a Collar Strategy?

The collar strategy in options is a setup that combines a protective put and a covered call on the same stock. You buy a put option to protect your downside. You sell a call option to collect a premium. 

In this strategy, the option premium helps reduce the cost of buying the put. When someone asks what collar strategy is, in simple terms, the answer is that it is a risk control method that sets a floor and ceiling for your trade.

This structure keeps losses limited and profits defined. It is commonly used when a trader already owns the stock and wants steady protection without spending too much.

Features of a Collar Strategy

A collar strategy has a clear structure that helps traders manage risk at a lower cost. This is possible because it uses a combination of put and call. Some of the features of the same are as follows

• Buy a protective put to limit downside risk.

• Sell a covered call to reduce the cost of the put.

• Both options use the same expiry date.

• Defines a profit range and a loss range.

• Best when you expect mild movement in the stock.

Pros of a Collar Strategy

The collar option strategy is popular because it helps traders stay invested without fear of a sudden fall. But there are some other benefits as well, which are:

• Limit losses during sharp market drops.

• Reduces the overall cost by selling a call.

• Stable position even in volatile markets.

• Protect gains on stocks that have already moved up.

• Avoid paying high premiums for safety.

Cons of a Collar Strategy

Even though the collar strategy in options offers protection, there are some downsides as well, like:

• Capped profit due to the covered call.

• Reduced benefits if the stock rallies.

• Not for aggressive traders who want high returns.

• Need to hold the stock.

• Manage two option legs along with the stock.

How the Collar Strategy Works

A collar strategy works by combining three parts. These are:

• Hold the stock

• Buy a put for safety

• Sell a call to reduce the cost of a put

This creates a range within which your profit and loss stay controlled. The steps followed are as below:

Step 1: Own the Stock

You must hold the stock before placing the options. The strategy starts only when you have the shares.

Step 2: Buy a Protective Put

You buy a put option at a strike price below the current stock price. This limits your downside if the stock falls.

Step 3: Sell a Covered Call

You sell a call option at a strike price above the current stock price. The premium from the call reduces the cost of buying the put.

Step 4: Hold Till Expiry

Your stock, put, and call move together. At expiry, the stock settles within your defined range.

Example of a Collar Strategy

Imagine you hold a stock currently trading at Rs. 1,000. You want protection but do not want to pay a heavy premium.

• You buy a put at Rs. 950 for Rs. 20.

• You sell a call at Rs. 1,050 for Rs. 20.

Your put cost becomes zero because the call premium covers it.

Now see how the payoff works:

If the stock falls to Rs. 900

Your put allows you to sell at Rs. 950, so your loss is limited.

If the stock rises to Rs. 1,100

Your call will be exercised. You must sell the stock at Rs. 1,050, so your profit is capped.

If the stock stays between Rs. 950 and Rs. 1,050

Both options expire worthless. You keep the stock and face no option cost.

This is how a collar strategy creates a controlled zone with limited loss and limited gain.

Conclusion

A collar strategy helps traders protect their position without spending much on premiums. It helps to create a safety net and manage the stocks when there is market downside. But it also marks a cap on your gains. Hence, it is important that you analyse well how you wish to use this plan. And if you are new and looking for some tools, support, and guidance, then start trading right with Rupeezy.

FAQs

What is a collar strategy in options trading?

A collar strategy is a combination of holding a stock, buying a protective put, and selling a covered call. It limits downside risk and caps upside.

Is a collar option strategy good for beginners?

Yes. It is simple to understand and offers controlled risk, which makes it helpful for traders who prefer protection.

Does a collar strategy reduce profit?

Yes. Your profit gets capped at the call strike, but you receive safety from large losses.

Why do traders use the collar strategy?

Traders use it to lock in gains, protect stocks during volatile markets, and lower the cost of buying protection.

Can I apply a collar strategy without owning the stock?

No. You must own the stock because the call leg is a covered call and requires share ownership.