Lesson 16 of 25 · 7 min
A collar: two legs, one band
Two contracts define a range; inside it the outcome is yours, and outside it on either side it is not.
A collar is the two previous lessons held at once: a put bought below the current price and a call written above it, on the same shares, usually with the same expiry. The put pays for itself partly or entirely out of the call.
Take 21,500 shares at $53.80, so $1,156,700. A put struck at $47 costs $3.10 per share, which is $66,650. A call written at $62 brings in $2.42 per share, which is $52,030. Net cost is $66,650 − $52,030 = $14,620, or 1.26 percent of position value, against 5.76 percent for the put alone.
The band is the two strikes. The floor is 21,500 × $47 = $1,010,500, and after the net cost the worst outcome is $995,880, which is 13.90 percent below the start. The ceiling is 21,500 × $62 = $1,333,000, and after the net cost the best outcome is $1,318,380, which is 13.98 percent above the start. Between the strikes the outcome is whatever the shares do, less $14,620.
A collar whose two premiums exactly offset is described as zero-cost, and the phrase is precise about cash and silent about everything else. No cash changes hands at the outset; the payment is made in the appreciation above the ceiling, which is unknown when the strikes are chosen. Moving the ceiling higher raises that payment's cap and lowers the premium received, which forces the floor down or a net cost up. The three quantities cannot be set independently.
Key terms
- Collar
- Shares held with a put bought below the price and a call written above it, producing a bounded range of outcomes.
- Band
- The range between the two strikes. Inside it you keep the shares' outcome; outside it one of the two contracts governs.
- Zero-cost collar
- A collar whose premiums offset exactly, so no cash is paid at the outset. The cost is paid in forgone appreciation instead.
Worked example
Where the band starts and stops
21,500 shares at $53.80, so $1,156,700. Put struck at $47 for $3.10; call written at $62 for $2.42. Same expiry. Illustrative prices.
- Put cost
- $66,650
- Call premium received
- $52,030
- Net cost
- $14,620
- Worst outcome
- $995,880
- Best outcome
- $1,318,380
- Width of the band
- 27.88 points
21,500 × $3.10.
21,500 × $2.42.
1.26% of position value.
(21,500 × $47) − $14,620, or 13.90% below the start.
(21,500 × $62) − $14,620, or 13.98% above the start.
13.90 + 13.98.
The put alone cost 5.76 percent of position value; the collar cost 1.26 percent and a ceiling. The difference between those two figures is the ceiling.
Check yourself
You hold 9,000 shares at $70. A put at $61 costs $4.20 per share and a call written at $82 brings in $3.05 per share. What are the worst and best outcomes at expiry?
Saved in this browser only. No account, nothing sent anywhere.
Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.