Protective Puts and Collars: Insuring a Stock Position

If you own a stock and fear a drop but do not want to sell, options can act as insurance. A protective put sets a floor under your position. A collar sets a floor and pays for it, at least partly, by capping your upside.

Protective put

Own 100 shares and buy one put.

Example: you own 100 shares at $100. You buy a $94 put for $2.50.

• Worst case at expiration: the stock falls below $94. You can sell at $94. Loss: $6 (stock) + $2.50 (put) = $8.50 per share, $850.
• Upside: unlimited, minus the $2.50 cost.
• Break-even: $102.50.

The put works like an insurance policy with a deductible ($6 here) and a premium ($2.50).

Collar

Own 100 shares, buy a put and sell a call.

Example: own shares at $100, buy the $92 put for $2.00, sell the $110 call for $2.00. Net cost: $0, a "zero-cost collar".

• Floor: $92. Maximum loss: $8 per share.
• Cap: $110. Maximum gain: $10 per share.

Choosing between them

Practical points

• Protection is not free. Buying puts regularly costs money over time, especially when implied volatility is high.
• Strike choice is a trade-off between how much protection you get and how much you pay or give up.
• Expiration: longer-dated puts cost more but decay more slowly per day. See theta decay.
• Taxes: hedging appreciated stock can have tax consequences in some jurisdictions. See Taxes and records.
• Early assignment of the short call in a collar is possible, especially before dividends.

In TradeThink

The stock and option legs appear together on the open positions page, and the risk profile shows the combined payoff of the hedge. Related: covered calls.