How a Collar Strategy Limits Risk

This guide explains how a collar works on an NSE stock and on Nifty futures, the numbers, how to choose the strikes and how to manage and automate it.

At a glance

How a collar works

A protective put sets a floor but costs a premium every time you buy it. A covered call earns a premium but gives no floor. A collar combines them: the call you sell funds the put you buy.

The result is a position with a known range of outcomes until expiry. It suits a holder who wants to protect a gain through a risky period, such as results or an election, without selling the shares.

The numbers on a stock

Take a hypothetical NSE stock at ₹1,400 with a lot size of 500 shares, 26 days to the monthly expiry and an IV of 24%. Black–Scholes model prices:

• Hold 500 shares bought at ₹1,400
• Buy the 1,340 put at ₹11.35
• Sell the 1,460 call at ₹15.85
• Net credit: ₹4.50 a share, or ₹2,250

The loss cannot exceed ₹27,750 and the gain cannot exceed ₹32,250, whatever the stock does before expiry. Buying the 1,340 put alone would cost ₹5,675.

Choosing the strikes

The put strike sets how much you can lose. The call strike sets how much you can gain. Moving either one changes the cost:

A collar with equal premiums on both sides is called a zero-cost collar. Stock options usually have fewer liquid strikes than index options, so check the bid and ask on both legs before you enter.

A collar on Nifty futures

The same structure works on futures. With Nifty at 25,000 and 12 days to expiry (IV 14%), the fair futures price is about 25,053:

• Buy one lot of Nifty futures at 25,053
• Buy the 24,700 put at ₹113.40
• Sell the 25,300 call at ₹150.10
• Net credit: ₹36.70 a unit

At expiry the loss is capped at about ₹20,560 per lot and the gain at about ₹18,440 per lot. Without the options, one lot of futures gains or loses ₹65 for every point.

What happens at expiry

Index options settle in cash. Stock options are physically settled: if the stock ends below the put strike, you deliver the shares at the put strike; if it ends above the call strike, you deliver them at the call strike. Close or roll the options before expiry if you want to keep the shares.

When a collar works, and when it does not

Works best when:

• You hold a position with a gain you want to protect for a set period.
• An event is coming and you want a defined range of outcomes.
• IV is high enough that the call pays for most of the put.

Struggles when:

• The stock rallies far past the call strike: the cap costs the move.
• You collar every month without a reason. Over time, giving up the large gains can cost more than the protection saves.

Managing a collar

• Roll with the price. If the stock rises toward the call strike, roll both options up to lock in a higher floor.
• Remove it after the event. Close the options once the risk you were protecting against has passed.
• Match the quantity. One lot of options covers one lot of shares or futures. A mismatch leaves part of the position unprotected or over-hedged.

Automating a collar

In QuantPower's strategy builder, set the two option legs against your holding with a rule for strike selection, such as the put 4% below the price and the call 4% above. Add a roll rule when the price moves a set distance, and a market alert for the expiry week. Test it in paper trading first.

Frequently asked questions

Sources

• Black, F. and Scholes, M. (1973). The Pricing of Options and Corporate Liabilities. Journal of Political Economy, 81(3), 637–654
• NSE: Equity derivatives contract specifications