What is a Collar? A Simple Guide for Indian Traders
A collar combines a protective put and a covered call on a holding. You buy a put to floor the downside and sell a call to fund it, capping the upside. The result is a position with both risk and reward bounded within a band.
A collar is a low-cost way to protect a holding. You buy a put for downside protection and sell a call to pay for it, boxing the position into a band.
This explainer keeps the language simple and the examples Indian. You can trade it on Stockk.
Key Takeaways
- It combines a protective put and a covered call.
- The put floors the downside.
- The sold call funds the put but caps the upside.
- It is often low-cost or nearly free.
- Both risk and reward are bounded.
How does a collar work?
The protective put sets a floor on losses, while the sold call generates premium that pays for the put, often making the collar low-cost or even free. The trade-off is that the call caps the upside. The position is locked into a band between the put and call strikes until expiry.
Let us say you hold a stock at ₹100, buy the ₹95 put for ₹3 and sell the ₹110 call for ₹3. The call premium exactly pays for the put, so the collar costs nothing to put on. Your loss is floored at ₹5 if the stock falls below ₹95, and your gain is capped at ₹10 if it rises above ₹110.
When investors use a collar
A collar suits investors who want low-cost downside protection and are willing to give up some upside to fund it. It is common for protecting gains in a holding ahead of uncertainty. The strategy bounds both risk and reward, offering stability rather than open-ended exposure.
Collar vs protective put
| Feature | Collar | Protective put |
|---|---|---|
| Downside | Floored | Floored |
| Upside | Capped | Open |
| Cost | Low or free | Premium paid |
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Futures and Options are leveraged products and carry a high risk of loss that can be more than the money you put in. This article is only for learning and is not a recommendation to trade in derivatives.
Frequently Asked Questions
How does a collar reduce cost?
The sold call funds the protective put, often making the collar cheap or free, with capped upside as the trade-off.
What does a collar protect against?
The put floors downside losses below its strike, guarding against a fall, while the call caps the upside.
When is a collar useful?
When protecting gains in a holding ahead of uncertainty, at low cost. It bounds both risk and reward for stability.
Does a collar cap my gains?
Yes, the sold call caps upside above its strike, which is the cost of cheap protection. Both ends are bounded.
How is a collar different from a protective put?
A collar adds a sold call to fund the put, capping upside, while a protective put leaves upside open.
Investments in securities market are subject to market risks. This article is for educational purposes only and does not constitute investment advice.
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