Collars and zero-cost hedges for a stock portfolio: pricing protection, choosing strikes and the upside you give up
Build a collar on a share position, price the protection, compare a zero-cost collar with a paid collar and measure exactly how much upside you sell.
What you will learn
- How a collar combines a protective put and a covered call, and why its net cost can be zero.
- How to price protection as a percentage of the position and as an annualised cost.
- How to choose put and call strikes so that floor, cap and cost match your goal.
- Why skew makes a zero-cost collar asymmetric and what else you give up besides upside.
Explanation
A collar is a hedge on shares you already own. You buy a put below the current price (the floor) and sell a call above the current price (the cap). The call premium pays for some or all of the put. The protective put and covered call on their own were covered in the course Derivatives (lesson der08); here we combine them and treat the choice of strikes as a pricing decision.
Key terms: the floor is the lowest value per share you can end up with at expiry (put strike minus net cost). The cap is the highest value (call strike minus net cost). The net cost is put premium paid minus call premium received. If the two premiums are equal the result is a zero-cost collar: no cash leaves your account, but you pay with upside.
Because out-of-the-money puts usually trade at higher implied volatility than out-of-the-money calls (the skew, lesson 2), a zero-cost collar is rarely symmetric: to finance a put 10% below the price you often must sell a call less than 10% above it.
Three practical rules of thumb:
- Decide the loss you can accept first, then find the put strike; only then look for a call that finances it.
- Match the expiry to the risk: short for an earnings date, usually 3–12 months for a concentrated position you cannot sell.
- Count the hidden costs: a short call on a dividend-paying share can be assigned early just before the ex-dividend date (lesson 10), and when the call expires in the money you must either deliver the shares or roll the call (lesson 9).
A collar is not free insurance: you give up the upside above the cap, and assignment may create a taxable event (check with a Steuerberater).
Worked example
Hypothetical example: you own 300 shares of a German company trading at €80 (position value €24,000). Eurex equity options usually cover 100 shares, so you trade 3 contracts per leg. Three-month option prices are assumed as follows. Fees, spreads, dividends and taxes are excluded.
| Variant | Put (buy) | Call (sell) | Net cost per share | Floor | Cap |
|---|---|---|---|---|---|
| A: zero-cost | €72 strike at €2.10 | €88 strike at €2.10 | €0.00 | €72.00 | €88.00 |
| B: tighter, paid | €76 strike at €3.40 | €86 strike at €2.30 | €1.10 debit | €74.90 | €84.90 |
Variant A: maximum loss per share = €80 − €72 = €8.00, or 10.0% of the share price. Maximum gain per share = €88 − €80 = €8.00 (10.0%). For 300 shares both the worst case and the best case are 300 × €8.00 = €2,400 for three months. Nothing is paid upfront, but any price above €88 at expiry belongs to the call buyer.
Variant B: net cost = €3.40 − €2.30 = €1.10 per share, or 300 × €1.10 = €330. Floor = €76 − €1.10 = €74.90, so the maximum loss is €80 − €74.90 = €5.10 (6.4%). Cap = €86 − €1.10 = €84.90, so the maximum gain is €4.90 (6.1%). The protection cost of €1.10 per three months is 1.375% of the share price; multiplied by four it is about 5.5% per year if you repeated it every quarter. That annual drag is the real price of a tight collar.
Variant A is cheap in cash but caps your gain at the same distance as your loss; Variant B cuts the possible loss but costs €330 now.
Common mistake
Practice activity
You hold 200 shares at €60. You buy a 2-month €54 put for €1.50 per share and sell a 2-month €66 call for €1.50 per share. Calculate the net cost, floor and cap, then the profit or loss on the shares plus options at expiry if the share price is €50, €60 and €72. Ignore fees and dividends.
Show solution
Net cost = €1.50 − €1.50 = €0 (zero-cost collar). Floor = €54, cap = €66.
- Price €50: shares −€10, put worth €54 − €50 = +€4, call worthless → −€6 per share = −€1,200. The loss is limited to the floor distance (€60 − €54).
- Price €60: shares €0, both options worthless → €0.
- Price €72: shares +€12, put worthless, call owes €72 − €66 = −€6 → +€6 per share = +€1,200. The gain is capped at the cap distance (€66 − €60).
Limitations: this is the result at expiry only; before expiry the collar's value depends on implied volatility and time, and early assignment of the call can change the outcome.
Key takeaways
- A collar = long shares + long put (floor) + short call (cap); the call finances the put.
- Price protection as net cost per share, as a percentage of the position and as an annualised drag.
- Skew usually makes a zero-cost collar asymmetric: floor further away than cap, or the cap closer than you would like.
- The upside you give up, early assignment around dividends and tax events are the real costs.
Next step
Next, lesson 9 shows how to manage positions over time: rolling out, up and down, delta adjustments and when to take profit early.
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