Educational Corner: Options Deep Dive - Collar Strategy

After a strong market rally, one of the most common questions I get from readers of The Option Premium is: “How do I protect my profits using options?” It’s a fair question. In investing, it’s not just about making money—it’s about keeping it.

The market, as we know, is indifferent to your gains. It doesn’t care how long you’ve been holding, how much effort you put into your research, or what your plans are for your profits. What it does care about is mean reversion—what goes up tends to experience pullbacks, sometimes violently.

But there’s good news: Options provide a way to hedge risk while maintaining exposure to further upside. One of the simplest and most effective strategies for doing this is the protective collar.

Why More Investors Should Use Collars

Despite its effectiveness, many retail investors shy away from using collars. Hedge funds and institutions rely on them regularly—so why don’t more individual traders?

The answer is simple: Greed.

Most investors don’t like the idea of “limiting their upside.” But professional traders know that risk management is what separates the survivors from the gamblers. Protecting gains doesn’t mean giving up on potential profits—it just means making sure you still have capital to trade another day.

The collar strategy is designed for traders and investors who:
✅ Want to protect unrealized profits without liquidating their position.
✅ Own stocks that they don’t want to sell (e.g., dividend stocks, core holdings).
✅ Prefer a low-cost hedge that doesn’t require constant babysitting.

How the Collar Strategy Works

The collar is essentially a covered call + protective put combined:

📌 Step 1: You own at least 100 shares of a stock or ETF.
📌 Step 2: You sell an out-of-the-money (OTM) call to generate income.
📌 Step 3: You use that income to buy an OTM put for downside protection.

By doing this, you:
✅ Cap your upside (if the stock surges, your shares may be called away).
✅ Limit your downside (your put acts as an insurance policy).
✅ Reduce or even eliminate the cost of hedging (your sold call pays for part or all of the put).

Example: Using a Collar on SPY

Let’s say you own 100 shares of SPDR S&P 500 ETF (SPY) and want to protect your profits while still participating in further upside.

🔹 Current price of SPY: $601.82
🔹 Goal: Limit downside risk while maintaining some upside exposure.

Step 1: Sell a Covered Call

We look for an OTM call with about 30-60 days to expiration and a delta around 0.30—meaning it has about a 30% chance of expiring in the money.

🔹 Sell the SPY 617 Call March 21, 2025 expiration, 47 days out) for $5.59 ($559 per contract).

This gives us income, which we can use to partially fund our protective put.

Step 2: Buy a Protective Put

Now, we buy an OTM put to protect against a 6% decline in SPY.

🔹 Buy the SPY 565 Put (April expiration, 74 days out) for $5.25 ($525 per contract).

This ensures that if SPY drops below $565, we are protected.

📌 Total Cost of the Collar:
💰 Put cost: -$525
💰 Call income: +$559
💰 Net cost of the hedge: +$34

By selling the call, we offset 106.5% of the cost of the put, turning the hedge into a small credit and reducing the overall expense. Additionally, we can continue to sell calls with future expirations to generate more premium. Plus, SPY can still capture capital gains up to the $617 call strike—offering the best of both worlds: downside protection with upside potential.

What This Trade Achieves

📈 If SPY Rises Above $617 → Our shares get called away, locking in a 2.5% gain ($15.18 per share) from current levels.
📉 If SPY Drops Below $565 → Our put kicks in, protecting us from further losses.
⚖️ If SPY Stays Between $565 - $617 → We keep our shares and can sell additional calls to further offset the cost of the hedge.

This strategy is not about making more money—it’s about protecting what you’ve already made. If you’ve held SPY over the last two years, your gains have likely exceeded 50%, thanks to the strong market rally. The goal here is to lock in those profits while still leaving room for additional upside, ensuring that a sudden market downturn doesn’t erase the hard-earned growth in your portfolio.

Why Collars Are an Essential Risk Management Tool

1️⃣ Low Cost, High Protection – Unlike buying a put outright (which can be expensive), the call sale helps reduce or eliminate the cost of hedging.
2️⃣ Defined Risk, Defined Reward – You know exactly how much downside protection you have and what your upside cap is—no surprises.
3️⃣ Allows for Flexibility – You can adjust strikes and expirations to fit your market outlook.
4️⃣ Better Than Just Holding and Hoping – Many investors watch their gains disappear in market pullbacks because they refuse to hedge—collars solve that problem.

Smart Investors/Traders Protect Their Gains

Options trading isn’t about picking tops and bottoms—it’s about managing risk in a way that allows you to stay in the game.

Too many traders get caught in the trap of hoping their positions will keep running higher indefinitely. But hope is not a strategy.

Instead, consider what professional traders already know: Markets move in cycles. Protecting profits during a strong rally isn’t being overly cautious—it’s being smart.

Adding collars to your strategy ensures that no matter what the market throws at you, you remain in control.

🚀 Trade wisely, manage risk, and keep your edge,

Andy Crowder

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