What is Collar Options Trading Strategy?

Last Updated: 16 Sep 2025

Everyone wants to multiply their wealth. However, those who understand the external factors that affect the returns on the money always turn to the Indian financial market for multiplying their wealth.

The Indian financial market is full of numerous investment opportunities that can offer higher returns with low-risk exposure. Furthermore, when you diversify among various asset classes, the risk factor decreases. One of the best ways, along with the equity market, is leveraging various Options Trading strategies to trade Options. They are contracts that grant the holder the right but do not bind them, to either buy or sell a sum of some underlying asset at or before the contract expires at a fixed price.

As there are numerous options trading strategies, very few offer steady profits with a very low-risk profile. One such strategy is the Collar Options Strategy, which combines one extra contract to lower the risk by a huge margin. However, before understanding what is a collar options strategy, let’s take a look at some basic terms associated with Options Trading.

Collar Options Strategy Terminology

Many professionals often wonder what is a collar strategy. To help you make informed decisions, here are the key terminologies you must know of –

• Call Options: A Call Option is a contract wherein you win the right, but not the obligation, to buy a certain underlying asset at a decided-upon price and date between the contracting parties.
• Put Options: A Put Option works exactly opposite to the call option. While the call option equips you with the right to buy, the put option empowers you with the right to sell the stock at the price on the date agreed upon by the contracting parties.
• Strike Price: The price at which the options contract was initially bought or the pre-determined price.
• Spot Price: The current price of the underlying asset is attached to the options contract.
• Premium: It is the price you pay to the seller of the option for entering into the online trading options.
• In-The-Money (ITM) option: When the underlying asset price is higher than the strike price.
• Out-of-the-money (OTM) option: When the underlying asset price is lower than the strike price.
• At-the-money (ATM) option: When the underlying asset price is identical to the contract’s strike price.

What is the Collar Options Strategy?

A collar is an options strategy designed to protect an existing stock position while controlling costs. The investor first purchases an at-the-money put option. This ‘put’ acts as insurance by guaranteeing a minimum sale price for the shares and therefore limits downside risk.

At the same time, the investor sells an out-of-the-money call option with the same expiration date. The premium received from this call generally covers most or all of the cost of the protective put.

When these two options are combined with the underlying shares, the investor’s potential loss is capped at the put’s strike price (plus or minus any net premium), and the potential gain is limited to the call’s strike price. The primary advantage of the collar is that it offers meaningful downside protection at little or no net cost; the trade-off is that upside participation is restricted once the stock price rises above the call strike.

How Does a Collar Options Strategy Work?

Practitioners describe the setup succinctly as a collar option strategy that pairs long shares with opposing options. Academics group it within the wider toolbox of collar strategy in options designed to define risk ranges. For a detailed understanding of how the Collar Options Strategy works, consider the following example:

Suppose you are holding the shares of ABC company currently trading at Rs 1,500, or you are planning to buy the shares with a view to the price going up soon. However, you also want to protect your capital in case the prices go down from the current levels. In such a case, you can implement the Collar Options Strategy, which would look like the following:

• Buy 1 ATM Put Option with a strike price of Rs 1,200- Rs 1Premium Paid: 1×100 = Rs 100
• Sell 1 OTM Call Option with a strike price of Rs 2,000- Rs 2Premium Received: 2×100 = Rs 200

Net Premium: Rs 100 (200-100).

The lot size is 100, and both the contracts have the same underlying asset and expiration date.

Scenario 1: The price of the stocks rises to Rs 2,500

In this case, you can sell the stock and make a profit of Rs 1,000 (2,500-1,000). With the net premium, it will increase to Rs 1,100 (1,000+100). The Put option will expire worthlessly, and you will have to pay Rs 500 for the call option.

Net Profit : Rs (1,000+100-500) = Rs 400

Scenario 2: The price of the stocks falls to Rs 1,000.

On paper, you will lose Rs 500 (1,000-1,500) but you can exercise the Put option to earn Rs 200 (1,200-1000). The call option will expire worthlessly.

Net Loss: (-500+200+100) = Rs 200

As you see, the Put option limits the loss by a huge margin which, otherwise, could have been higher.

Advantages & Risks Associated With Collar Options Strategy

Many new investors first ask, what is a collar option strategy. In daily chat rooms and desks, it is casually called collar trading.

• The primary benefit is selling the out-of-the-money call harvests premium, often covering much or all of the protective put, making the hedge nearly cash-neutral while still allowing moderate stock appreciation.
• The defined downside from the long put supplies psychological comfort and compliance clarity for managers who must disclose maximum loss, a factor that helps institutional portfolios maintain risk budgets.
• Income collected each cycle lowers share basis and smooths returns, a buffer during flat or choppy markets where equities stagnate and dividends alone may not meet required yield targets.
• Risk emerges if the stock gaps below the put strike or if assignment on the call forces an unwelcome, taxable share disposal, both scenarios potentially undoing the intended hedge benefits.
• Ongoing attention is essential because capped upside, rolling logistics, bid-ask spreads, and commissions can gradually erode the strategy’s appeal, demanding time, trading skill, and disciplined record-keeping.

Finally, volatility skews can shift option pricing, occasionally making collars expensive precisely when investors most crave protection, and market liquidity suddenly dries up badly.

Limitations of Collar Options Strategy

• Profit ceiling confines gains to the call’s strike plus collected premium, so investors cannot fully participate in explosive upside moves that lift long-term wealth.
• If implied volatility collapses after initiating the position, the protective put can lose significant value, leaving the cost of insurance disproportionate to remaining safety.
• Large overnight gaps below the put strike may bypass its protection until the option market reopens, exposing holders to deeper losses than theoretical payoff diagrams suggest.
• Early assignment risk on the short call can force an untimely share sale, potentially triggering adverse tax consequences or disrupting dividend capture strategies.
• Rolling the collar to a later expiration requires paying commissions and bid-ask spreads twice, incrementally eroding total return, especially in thinly traded names.
• Option liquidity can vanish during stressed markets, making it expensive or impossible to close or adjust positions at the desired price level.
• Because upside is capped, portfolios using collars must own additional high-beta assets to meet aggressive growth mandates, complicating asset allocation and risk budgeting processes.
• Correlation shifts between stock and volatility can reduce hedge effectiveness; a calm drawdown may leave the put expensive while the underlying slips steadily lower.
• Complex option Greeks (gamma, vega, and theta) interact continuously, so maintaining a collar demands monitoring and adjustments that some investors lack the time or expertise to perform.
• Finally, seemingly small costs (assignment fees, regulatory charges, and wider spreads during after-hours trading) compound over multiple rolls and can meaningfully undercut the strategy’s advertised risk-adjusted return.

These drawbacks warrant thorough scenario testing before real money capital is committed.

When should you use Collar Options Strategy?

The best time to use the Collar Options Strategy is when you expect the price of a certain stock to go higher than the current levels. If it goes higher, you earn the maximum profits through exercising the Call Option and the net credit of premium.

Frequently Asked Questions

Is Collar a good strategy?

Yes, a collar is a good Options strategy as it comes with a very low-risk exposure for the trader.

Is Collar strategy profitable?

Yes, a collar strategy is profitable if the stock price reaches the Call option’s strike price. However, the profit potential is limited in the collar strategy.

What is a collar position?

A collar position is when you buy an ATM (at-the-money) Put Option and simultaneously sell an OTM (out-of-the-money) Call Option.