If you’ve been selling covered calls for any length of time, you’ve probably experienced that sinking feeling when a stock you own drops 10% or more in a week. The premium you collected? It helped, but it didn’t come close to covering the drawdown. And that’s the one weakness of a standard covered call — it gives you income, but no real floor under your position.
That’s where the collar strategy comes in. It’s one of the most elegant risk management tools in options trading, and I use it regularly in my own portfolio when I want to protect gains without exiting a position. Today I’m going to break down exactly how the collar works, when to use it, and how it fits alongside the covered call income strategies I teach in my Cash Flow Machine system.
What Is a Collar Strategy?
A collar is a three-part position:
- Own 100 shares of the underlying stock
- Sell 1 out-of-the-money call (your covered call — generates premium and caps upside)
- Buy 1 out-of-the-money put (your protective floor — limits downside)
Think of it this way: the covered call portion generates income, and you use some or all of that income to buy a put that acts like an insurance policy. If the stock tanks, the put kicks in and limits your loss to a known, fixed amount. If the stock goes up, you profit up to the call strike — same as any covered call.
The result is a position that is “collared” between two price levels: a floor (the put strike) and a ceiling (the call strike). Your profit is limited, your loss is limited, and in many cases it costs you little to nothing to set up.
A Real-World Collar Example
Let me walk you through an actual trade setup so you can see exactly how the numbers work.
Say you own 100 shares of AAPL trading at $220. You’re bullish long-term but worried about near-term volatility — maybe there’s an earnings report coming or the broader market looks shaky.
| Position | Details |
|---|---|
| Own 100 shares AAPL | Cost basis: $220 ($22,000 total) |
| Sell 1 AAPL $230 call (30 days out) | Collect $4.50 premium ($450) |
| Buy 1 AAPL $210 put (30 days out) | Pay $3.80 premium ($380) |
| Net credit | $0.70 per share ($70 total) |
Here’s what happens at expiration depending on where AAPL ends up:
| Scenario | Stock Price | Outcome | Profit/Loss |
|---|---|---|---|
| Stock rallies | $240 | Called away at $230 | +$1,070 ($1,000 stock gain + $70 net credit) |
| Stock flat | $220 | Both options expire worthless | +$70 (net credit) |
| Stock drops | $200 | Put protects below $210 | -$930 ($1,000 stock loss + $70 credit, floored at $210) |
| Stock crashes | $180 | Put protects below $210 | -$930 (same — loss capped at put strike) |
Without the collar, a drop to $180 would cost you $4,000. With the collar, your maximum loss is $930 no matter how far the stock falls. That’s the power of having a defined floor.
Collar vs. Covered Call: The Trade-Off
Let me be straightforward about this — there’s always a trade-off with the collar strategy, and you need to understand it before deciding whether to use it.
| Feature | Covered Call | Collar |
|---|---|---|
| Income generated | Full premium kept | Reduced (call premium minus put cost) |
| Downside protection | Minimal (premium buffer only) | Strong (loss floored at put strike) |
| Max loss potential | Unlimited (stock can go to zero) | Limited and known |
| Complexity | 2 legs (stock + call) | 3 legs (stock + call + put) |
| Best used when | Neutral to mildly bullish | Bullish but concerned about downside |
In my Cash Flow Machine system, the three strategies — Fortress, Balance Point, and Rocket — are all income strategies focused on generating consistent monthly cash flow. The collar isn’t a replacement for these approaches — it’s an additional tool you can layer on when conditions warrant extra protection.
When I Use Collars
I don’t collar every position. That would eat into my income too much. But I do use collars in specific situations:
- Ahead of earnings: If I have a stock with a big earnings report coming and I don’t want to exit the position, I’ll collar it to cap my downside through the announcement.
- Market uncertainty: When the VIX spikes or there’s a macro event (Fed decision, geopolitical tension), I may collar my largest positions for 30-60 days.
- Protecting large gains: If a stock has run up 30-40% and I’m sitting on big unrealized gains, a collar lets me protect those gains without triggering a taxable sale.
- Concentrated positions: If one stock is a disproportionately large part of my portfolio, a collar reduces the risk of a single-stock meltdown.
The Zero-Cost Collar
One of the most attractive variations is the zero-cost collar, where the premium from selling the call exactly offsets the cost of buying the put. In this scenario, you’re getting downside protection for free.
The catch is that to make the premiums match, you typically need to bring the call strike closer to the current price (giving up more upside) or push the put strike further away (getting less protection). It’s a balancing act.
For example, with AAPL at $220:
- Sell the $225 call for $6.20 and buy the $210 put for $3.80 — net credit of $2.40 but tighter upside cap
- Sell the $230 call for $4.50 and buy the $215 put for $4.50 — zero-cost collar with tighter floor
- Sell the $235 call for $3.00 and buy the $205 put for $2.80 — near-zero cost with wider range on both sides
Each configuration gives you a different risk-reward profile. The key is choosing the width that matches your outlook and risk tolerance.
How to Set Up a Collar Step by Step
Here’s my process when I decide to collar a position:
- Step 1: Identify the position you want to protect and decide how much downside you’re willing to accept (this determines your put strike).
- Step 2: Look at the options chain 30-45 days out. I prefer monthly expirations for collars because they give the position time to work and they have better liquidity.
- Step 3: Find the OTM put at your desired floor level. Check the premium cost.
- Step 4: Find the OTM call that generates enough premium to offset most or all of the put cost.
- Step 5: Execute both legs simultaneously. Many brokers let you enter a collar as a single multi-leg order.
- Step 6: Monitor the position. If the stock moves strongly in one direction, consider rolling one or both legs.
Risk Management Considerations
The collar itself is a risk management strategy, but there are a few nuances to keep in mind:
- Early assignment risk: If the stock moves above your call strike and pays a dividend, you may face early assignment. This is manageable — you sell the stock at a profit — but it can disrupt your collar. I cover this scenario in detail in my post on what happens during covered call assignment.
- Rolling the collar: If the stock drops toward your put strike but you remain bullish, you can roll the entire collar to a new expiration. Sell the current put (now more valuable), buy back the call (now cheaper), and re-establish both at new strikes. This is similar to rolling covered calls.
- Tax implications: Collars can affect your stock’s holding period for tax purposes, similar to how covered calls do. If you’re holding a stock for long-term capital gains treatment, be careful with strike selection. I covered this in depth in my covered call tax strategy guide.
Frequently Asked Questions
Is a collar the same as a covered call with a protective put?
Yes, exactly. A collar is simply a covered call (own stock + sell a call) combined with a protective put (buy a put below the current price). The three components together create a position with both a floor and a ceiling on the stock price. The key difference from a standalone covered call is that the put provides defined downside protection.
How much does a collar strategy cost?
The cost depends on the strike prices you choose. In many cases, you can set up a “zero-cost collar” where the call premium fully offsets the put premium. If you want tighter protection (higher put strike), the collar may cost a small debit. If you accept a lower floor, the collar can actually generate a small net credit. The goal is to balance your desired level of protection against how much upside you’re willing to cap.
When should I use a collar instead of a regular covered call?
Use a collar when you’re concerned about significant downside risk in the near term but don’t want to sell the stock. Common triggers include upcoming earnings announcements, elevated market volatility (VIX above 25), large unrealized gains you want to protect, or concentrated stock positions. For normal market conditions where you’re comfortable with the risk, a standard covered call is typically more income-efficient.
Can I use collars in my IRA?
Yes. Since a collar involves owning stock, selling a covered call, and buying a put, all three components are allowed in most IRA accounts. No margin is required. This makes collars an excellent hedging tool for retirement accounts where you want to protect your nest egg during volatile periods. Learn more about running options strategies in your IRA.
The Bottom Line
The collar strategy is one of the most powerful risk management tools available to stock and options investors. It’s not about maximizing income — it’s about protecting what you’ve built during uncertain times while maintaining your position for the long term.
In my Cash Flow Machine system, I focus on generating consistent monthly income through covered calls using the Fortress, Balance Point, and Rocket strategies. The collar is a tool I keep in my back pocket for those times when the market gets choppy and I want an extra layer of protection without liquidating positions.
If you want to learn how I combine income generation with smart risk management, watch my free 50-minute MasterCourse. I’ll show you the complete Cash Flow Machine system and how to build a portfolio that generates consistent cash flow in any market environment.
For more strategy breakdowns, visit my covered call strategy page and subscribe to the @coveredcalls YouTube channel for weekly trade reviews and market commentary.
This article is for educational and informational purposes only and should not be construed as financial advice. Options trading involves risk and is not suitable for all investors. Consult a qualified financial professional before making investment decisions. Past performance does not guarantee future results.