Understanding Collar Strategy

Understanding the Collar Strategy: A Practical Guide for Everyday Investors

Stock markets rarely move in a straight line. One week your portfolio looks perfect, and the next, a sudden drop can shake your confidence. To handle these unpredictable swings, many investors turn to risk-management tools—one of the most popular being the Collar Strategy.

If you’ve ever wished for a way to protect your gains without giving up too much upside, a collar might just be worth exploring.

What Is a Collar Strategy?

A collar strategy is an options-based approach used by investors to limit potential losses while still keeping some room for gains. It works by combining two simple moves:

1. Buying a Put Option – This acts like an insurance policy. It gives you the right to sell your stock at a pre-decided price if the market falls.
2. Selling a Call Option – This generates premium income, which helps cover the cost of buying the put. But doing so limits how much profit you can make if the stock shoots up.

Think of it like this:
You’re building a protective boundary around your investment—your losses are capped, and so are your gains. Hence the name “collar.”

Why Do Investors Use a Collar?

Here are a few common reasons:

1. Protecting Profits After a Rally

If your stock has already given you solid returns, a collar helps you lock in some of those gains.

2. Reducing Downside Risk

Many long-term investors use collars when the market feels shaky or when they expect short-term volatility.

3. Low-Cost Hedging

Because selling a call brings in premium income, the cost of buying a put becomes more affordable.

How a Collar Strategy Works (Simple Example)

Imagine you own 100 shares of a stock trading at ₹1,000.

• You buy a put option with a strike price of ₹950.
  This ensures you can sell your shares at ₹950 even if the price crashes.
• You sell a call option with a strike price of ₹1,080.
  If the stock crosses ₹1,080, you must sell your shares at this price.

Outcome?

• If the market falls → Your loss is limited to the ₹50 difference (plus/minus premiums).
• If the market rises → Your maximum gain is capped at ₹80.

You get protection on the downside but sacrifice unlimited upside.

Is a Collar Strategy Right for You?

A collar is suitable for:

• Long-term investors who want steady growth without stomach-churning volatility
• Investors sitting on good profits and want to “lock in” gains
• People uncomfortable with large downside risks
• Those who prefer hedging without spending a large premium

It may not be ideal for investors who want to capture unlimited upside potential.

Pros and Cons of a Collar Strategy

✔ Pros

• Protects against big losses
• Reduces hedging cost
• Helps preserve accumulated profits
• Works well during uncertain markets

✘ Cons

• Caps your maximum upside
• Requires basic understanding of options
• Premium movements can still impact returns

If you're exploring hedging strategies like collars but aren’t sure how to execute them, platforms such as JM Financial Services offer research-backed guidance, market insights, and expert support to help investors understand option structures, risk profiles, and suitable market conditions. Their advisory team often helps clients design hedging strategies aligned with their long-term investment goals.

FAQs on Collar Strategy

1. Do I need to own the stock to use a collar strategy?

Yes. A collar is designed for investors who already hold shares and want to hedge them.

2. Is the strategy expensive?

Not usually. The call premium often offsets most of the put premium cost.

3. Can beginners use a collar strategy?

Yes, it’s one of the more beginner-friendly options hedging methods.

4. What happens if the stock price stays flat?

Both options may expire worthless, and you only lose or gain the net premium.

5. Is a collar the same as a covered call?

A covered call protects only your upside; a collar protects your downside as well through a put option.