I see collars often mentioned as downside protection for a stock you own. My question is: How?

Let's say you bought at stock at 45 and it is now 50. You can collar the 45 cost basis (one strike above 45 and one below). This is considered downside protection.

Now the stock moves down to 45. Then continues to 39, 37, 35. The collar expires. The stock is now 34. Where's the downside protection? Even if the collar is still on, where is the downside protection?


The stock is currently at 50.

Write a covered call at a strike price of 55. Use the money received from the covered-call-write to buy a put at a strike price of 45.

The position keeps the upside to a stock price of 55 but has no more upside beyond 55. Or the position will have gain on the put at anything less than 45 which is the downside protection.

Options are for a limited amount of time.

  • What happens when the options expire and the price is at 44? – 4thSpace Dec 23 '18 at 1:47
  • @4thSpace: In-the-money options in most exchanges are automatically exercised right before expiration. Ask your broker if this is true for you. – Ben Voigt Dec 24 '18 at 16:57
  • @BenVoigt: Doesn't the 50 call and the 45 put cancel each other out at expiration? You're then left holding the bag (exposed) with an upside down 50 cost basis stock while the price is at 37. – 4thSpace Dec 24 '18 at 22:31
  • @4thSpace: What? No, the 50 (or 55, according to the answer) call is worthless, no one will exercise it against you at 50 when they can buy on the market for 37. – Ben Voigt Dec 25 '18 at 4:09
  • The short call and long put only balance each other at the stock price when you bought the collar. If the stock price goes down, the put becomes worth more and the call becomes less of a liability. If the stock price goes up, the call becomes a greater liability and the put devalues. But your stock value went up. The collar has the effect of reducing your exposure to the market. – Ben Voigt Dec 25 '18 at 4:15

If you have a put option, you can choose to sell at its strike price (this is called exercising the option) rather than the stock's market price.

  • Exercising the long put to close the equity position is the better choice (1) if the put's bid is less than its intrinsic value (avoids the haircut), (2) it avoids leg out risk, (3) if your broker does not charge for assignment and exercise, – Bob Baerker Dec 22 '18 at 20:28
  • Can you show an example of this? You can use ~$7 for commission. – 4thSpace Dec 23 '18 at 1:49
  • You own a $150 put expiring in an hour and the stock is $145 ($5 intrinsic value). Quote is $4.75 x $5.25 so that's a 25 cent haircut ($25) at the market. Putting in a higher bid has gotten you nowhere because there is no incentive for the market maker to do so. Short the stock (first) and then exercise the put. If you pay for assignment and exercise (A&E), that's $14 in commissions to save $11. I pay $1 for the short with free A&E so it's $1 to save $25. Heck, I'll do it for a nickel. 20 contracts saves $80. – Bob Baerker Dec 24 '18 at 2:33
  • I'm talking about a $600 drawdown and you're worried about saving $11. I think you're in the wrong trade. You can't short a stock you own. Also, the OP doesn't own a $150 put. Again, wrong trade. You say nothing about where you bought, which strikes, etc. Too vague. – 4thSpace Dec 24 '18 at 13:28
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    Yep, you're right, I mucked this one up. That explanation was applicable for closing an unencumbered long ITM put or call where the bid is less than the intrinsic value. our situation is similar when you add the long equity to the position. If stock bot @ $45 and assuming it was a no cost collar then put cost was zero (ignoring commissions). If stock at $40 and put is $4.75 x $5.25 then if you sell both, that's a 25 cent haircut plus $14 in commissions. Exercise put and you avoid the haircut and pay same commish assuming exercise and sell commish are same). If free A&E, no closing cost. – Bob Baerker Dec 24 '18 at 16:52

Where's the protection?

  • If you buy a stock for $50 and it drops to $20 by expiration, the loss is 30 points.

  • If you buy a stock for $50 and you execute a 45p/55c no cost long stock collar, the loss is only 5 points at expiration.

If you want more protection or a higher reward potential, you can shift the risk graph by selecting strikes that are not equidistant away from share price. This will result in some amount of debit to put on the collar.

Prior to expiration, as the underlying drops, the put increases in price and the call decreases in price. As a hypothetical example, if these were 30 IV options and the stock dropped immediately, the net loss might be only 3 points at $45. The higher the IV, the less the loss would be. The closer you are to expiration, the lower this mitigating factor would be.

If the underlying collapses below the long put strike and IF you still want to own the underlying, you could roll the options down, lowering your cost basis. This will add more potential loss but will lower your upside break even price.

Note that long collared stock is synthetically equivalent to a vertical call spread so if opening all 3 legs simultaneously, consider the 2 legged critter to potentially reduce commissions and B/A damage.

  • And one day after expiration the loss is? If the stock is at 44, the loss is $600 per 100 shares held. What good did the collar the do? – 4thSpace Dec 23 '18 at 1:52
  • @4thSpace - (1) What good did the collar the do? The collar cost you nothing. It protected you from loss below the price of $45. (2) Try again. At expiry, what's the $$5 call worth and what's the $45 put worth? – Bob Baerker Dec 23 '18 at 14:53
  • At expiry, the spread (collar) will be worth nothing. Now you are exposed to 44 and -$600 per 100 shares held. It works while the collar is on, but once it expires, too bad. – 4thSpace Dec 23 '18 at 18:10
  • Sorry for the typo. It was meant to read: At expiry, what's the $55 call worth and what's the $45 put worth? – Bob Baerker Dec 24 '18 at 2:09
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    You question/complaint is unclear. If the stock is $44 at expiration then the put saved you $100. If the stock is $44 after expiration, then it's a silly question because options are for a limited time. Why in the world would you expect an expired option to protect you for subsequent price change? At expiration of the initial collar, if you want ongoing protection, add another no/low cost collar to move the protection forward in time. If your complaint is that you lost $5 from the drop from $50 to $45, that's not the fault of the options. That was just a poor investment choice. – Bob Baerker Dec 24 '18 at 2:10

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