Many investors see options trading as little more than a way to add speculative leverage to their portfolios.
But the fact is, options can help generate yield from existing positions (through selling covered calls, for instance) and they can help you insure your portfolio against loss.
And using those two strategies together can help you do a little bit of both. In essence, you use the yield you generate from selling calls to pay for your insurance.
The strategy I want to discuss today is known as a collar, and the strategy’s goal is to preserve hard-earned capital while simultaneously allowing a position to continue making profits.
Unfortunately, greed often deters individual investors from using collars. Hedge funds and even, large institutional managers frequently use collars, so why aren’t most individual investors using this safe, protective options strategy?
It’s because most investors don’t realize that collars not only protect their unrealized profits, they also allow you to hold a position that you don’t want to sell but for which you want some downside protection just in case the stock takes a fall. Think earnings surprises, or if you own a stock that pays a healthy dividend that you want to keep holding through what you feel is a correction phase for the market. Or maybe investors simply don’t realize they are one of the cheapest, yet most effective ways to reduce risk.
It doesn’t really matter the reason; it only matters that you’re aware of this strategy to keep risk in hand. Because the most important aspect of successful, long-term options investing is a disciplined approach to risk management. Without it, even the best strategies are inevitably doomed.
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A collar is an options strategy that requires an investor, who already owns at least 100 shares of a stock, to purchase an out-of-the-money put option and sell an out-of-the-money call option.
Think about it as a covered call coupled with a long put.
1. Long Stock (at least 100 shares).
2. Sell call option to finance the purchase of the protective put.
3. Buy put option to hedge downside risk.
Collar Option Strategy = long stock + out-of-the-money long put + out-of-the-money short call
You can actually finance most of your protection, so the cost of a collar is limited, if not free. Again, this is why intelligent investors and professional traders use collars habitually.
I’m going to use the heavily traded S&P 500 ETF (SPY) for my example, but you can apply this technique to any stock or ETF in your portfolio.
Let’s say we own 100 shares of SPY and would like to protect our return going forward. We still want to hold the ETF and participate in further upside. But we also realize that the ETF has had an incredible run over the last few years and want some downside protection, specifically over the short to intermediate term.
The ETF is currently trading for 686.61.
1. With SPY currently trading for 686.61, we want to sell an out-of-the-money call as our first step in using a collar option strategy.
A good place to start is with a call that has roughly 30-60 days left until expiration. So, to keep things simple, I am going with the February 20, 2026, 700 call options that are due to expire in 37 days.
I don’t want to sell calls that are too far out of the money because I want to bring in a decent amount of premium to cover most, if not all, of the protective put I’m going to buy.
The SPY February 20, 2026, 700 call fits the bill. We can sell the 700 call option for roughly $6.68, or $668 per call. We can now use the $668 from the call sold to help finance the put contract needed to achieve our goal of protecting returns.
2. The next and final step is to find an appropriate protective put to purchase. There are many different ways to approach this step, mostly centered around which expiration cycle to use. Should we go out 30 days to expiration? 60 days? 120 days? It really is up to you to decide.
I prefer going out as far as I can without paying too much for my protective put.
I’m going to go out to the April 17, 2026, expiration cycle with 93 days left until expiration. I plan on buying the 665 puts for roughly $12.84, or $1284 per put contract. This begins to cover any losses below 665, with a true breakeven (where the loss of the underlying position is greater than the loss of the position plus the collar) of 658.84.
*If you wanted to lower the cost of your puts you could simply buy a put at a lower strike. You would give up some downside protection by doing so, but the cost of the protective put would be less.
This means that more than half of the entire cost of the April 665 puts will be covered by selling the February 700 calls….and we can sell additional calls after our February 700 expires (say, in March or April) to cover the rest of the cost of our April 665 puts.
Total Cost: April 665 puts ($1284) – February 700 calls ($668) = $616 debit
Again, we can cover the entire cost of our April puts and actually add to our return, by selling more calls in March and April while still maintaining protection over the next 93 days.
So, as it stands, our upside return is now limited to 700 over the next 37 days. If SPY pushes above 700 per share, at February expiration, our stock would be called away. Basically, you would lock in any capital gains up to the price of 700.
But the key reason to use the strategy is not about making additional returns, it’s about protecting profits.
And through using a collar option strategy, in this instance, you are protected if SPY falls below 665 (where we purchased our put option). Essentially, at a premium of under 1% of your portfolio position (for the initial collar), you can insure your position against a sharp pullback.
And should SPY decline slightly or trade sideways, further call sales can more than offset that initial cost.
Options investing using collars limits your risk at an incredibly low cost and allows you to participate in further, albeit limited, upside profit potential. I’m certain you won’t regret adding this easy, yet effective options strategy to your investment toolbelt.
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*This post has been updated to reflect market conditions.
