Collars and put spreads

The protective put's problem is its price. The two standard ways to pay for it are to sell a call above the position (a collar) or to sell a lower put beneath the protective one (a put spread). Each one gives something up: the collar gives up the upside, the put spread gives up the deep tail. Which one you choose is a statement about which of those you can live without.

The collar

Index ETF at $400, 100 shares. Buy the 90-day $360 put at $4.40, sell the 90-day $440 call at $4.00. Net cost $0.40 per share, $40.

The position now lives inside a band: it cannot lose more than $4,040 (−10.1%) and cannot make more than $3,960 (+9.9%) over the 90 days. It cost $40 to build. A zero-cost collar sells a call whose premium exactly matches the put, here a strike around $436, and narrows the upside a little more.

Collar: long shares, long $360 put, short $440 call

  +3,960 |                    _______________
         |                  /
       0 |----------------/---------------------
         |              /
  -4,040 |____________/
         +----+----+----+----+----+----+
         320  360  400  440  480  520   ETF at expiry

A collar is, in payoff terms, a bull call spread between the two strikes plus cash. It suits:

• Concentrated positions you cannot or will not sell, typically for tax reasons: founder stock, a large inherited holding, vested employer shares. The collar locks in a range while deferring the sale.
• A defined holding period with a view that the upside is limited anyway.

It does not suit a broad, long-term equity portfolio. Continuously collared portfolios have, over long periods, given up more in capped rallies than they saved in floored declines, because equity markets rise more often and by more than the call strike allows. The collar's cost is not the $40; it is the difference between +9.9% and whatever the market did above $440.

Two mechanics: the short call is subject to early assignment before an ex-dividend date if it goes in the money (Module 2), and if it is assigned you have sold the shares, which for a tax-motivated collar is exactly the event you were avoiding. Use European-style index options where possible, or stay on top of the dates.

The put spread hedge

Same shares. Buy the $360 put at $4.40, sell the $320 put at $1.20. Net cost $3.20, $320.

The spread protects exactly the band between $360 and $320: a 10% to 20% decline. Above $360 you are unhedged minus the premium; below $320 you are unhedged again, $4,000 better off than you would have been. A 30% crash still costs 20.8%. The saving is $120 per quarter against the full put, and the price is the tail.

Side by side

Read down the columns and the trade-offs are explicit. The put pays for everything and keeps everything. The collar pays for almost nothing and keeps nothing above $440. The put spread pays for most of it and keeps the upside but not the crash. There is no row in which one of them is best everywhere; that is what "no free hedge" means in a table.

Choosing

• Worried about a crash, want the upside: protective put, and accept the bleed.
• Worried about a correction, think a crash is unlikely in the window, want the upside: put spread.
• Cannot sell the position, do not need the upside for now: collar.
• Worried about the cost most of all: partial hedges of any of the three, sized to the loss you cannot tolerate rather than to the whole position.

The options profit calculator will overlay all three on the same chart; do that with real quotes before choosing, because the relative prices of the strikes change with skew and IV.

Key idea: A collar funds the put by selling the upside; a put spread funds it by selling the tail. Both cut the cost of protection and both give something up, and over long periods the collar's capped rallies have cost more than its floors saved. Pick the structure by which loss you can live with, then size it to the loss you cannot.

Try it: With real quotes on a broad index ETF, build the protective put, a near-zero-cost collar and a 10%/20% put spread, all 90 days out. Fill in the side-by-side table at −30%, −20%, −10%, 0, +10%, +20%. Write one sentence for each about who should own it.

Recap

• A collar is a long put plus a short call; it creates a band (about −10% to +10% here) for near-zero cost by selling the upside.
• Collars fit concentrated positions you cannot sell; continuously collaring a long-term portfolio has historically cost more than it saved.
• A put spread hedge protects only between its strikes; here a 10–20% decline, at about 70% of the full put's cost.
• Below the lower strike the put spread's protection stops; a crash is still a crash minus the spread's width.
• Compare all three in one table at the same prices; no structure wins every row.