What is Collar?

Collar refers to the option strategy that controls loss and profit in investments. Ideally, the strategy is to control the losses, but it also limits your gains. You can create this option strategy by purchasing the put and selling the Call Option. The put guarantees the investors’ security if the price of the security drops.

The short position is used for the Call option, while the long position is for the Put Option. You can maximize your profits by using the long position on securities when the prices increase.

Collar Strategy Meaning

A long collar strategy works for security that has significant unrealized profits. The strategy is also used by the investors that believe the price of the stocks will rise in the future, but are not certain of the other short-term prospects. Both long-and short-term investors use the collar strategy as a hedging option.

For those who have a long position on the securities, the collar strategy is a viable option to limit your losses. Another area where the collar strategy can be implemented is for the securities that have long-term potential but comes with great short-term risk.

Also referred to as the hedge wrapper, the collar strategy is implemented to offer protection to the investor from losses. The strategy works wonders for those Investing in long-term securities, but it can also limit your gains. The investor has to purchase the put option while writing the call option to implement the collar strategy.

Collar Strategy Example

Suppose Jason has been holding a security for the past few years, the price of which has hiked from INR 4500 to INR 5000. Jason is not certain about the future prices of this security. In other words, he is not sure whether the prices of the security will increase or drop. He applies a collar strategy to limit the losses. He purchases the put option that comes with a strike rate of INR 4000 and a premium of INR 300. At the same time, he writes the call option for INR 300 that has a strike rate of INR 6000.

If the price of the security drops to INR 4000,

• The buyer will not execute the call option they have purchased from you, and you will get the payout of INR 300.
• Your put option that is worth INR 300 will be executed with the strike rate of INR 4000, which means you will get the payout of INR 300
• The cost of the Underlying security is INR 4000, which means that you will have to bear a loss of INR 1,000.

Here, the put option will protect you from a significant loss, which ideally happens when there is a sudden fall in the price of the securities. The loss with this strategy would be lesser than the loss you would have experienced without implementing the put and call spread collar strategy.