A “collar” can mean different things, but in investing it is a specific options strategy designed to limit both losses and gains on a position.
What a collar is
In finance, a collar is created by holding the underlying asset (for example, shares of a stock) while simultaneously buying a put option and selling a call option on the same asset. The put option sets a floor on how much you can lose, and the call option sets a cap on how much you can gain.
How it works step by step
- You own or buy the stock (or futures position) you want to protect.
- You buy an out-of-the-money put option, which gives you the right to sell at a specific lower price, limiting downside risk.
- You sell an out-of-the-money call option, which obligates you to sell the stock if it rises above a certain higher price, limiting upside but generating premium to help pay for the put.
What the collar achieves
The collar defines a price range in which your effective outcome will lie: you will not lose more than roughly the distance from the current price down to the put strike, and you will not gain more than roughly the distance up to the call strike (ignoring costs and small adjustments). This is often used by investors or producers (like farmers or energy companies) to hedge against large adverse price moves while accepting a limit on potential profits.
Key features at a glance
Aspect| Put leg (floor)| Call leg (cap)
---|---|---
Purpose| Protects against large price declines| Limits profit if price rises
too much
Position| Long put (you buy the option)| Short call (you sell the option)
Effect on cash flow| Requires paying a premium| Brings in premium income
Risk effect| Sets a minimum exit price for the underlying| Sets a maximum
effective sale price for the underlying
Typical moneyness| Often out-of-the-money, below current market price| Often
out-of-the-money, above current market price
If by “collar” you meant a different context (like a medical brain-protection collar or a physical collar on clothing or pets), say which one and more detail can be given.
