Protective Puts and Collars
Protective Puts and Collars
Protective puts and collars provide downside protection for long stock positions. The protective put establishes a floor price, while the collar adds a call sale to offset the put cost. Both strategies sacrifice some upside potential to reduce downside risk.
Definition and Key Concepts
Protective Put
A protective put (also called a married put) combines:
- Long 100 shares of stock
- Long 1 put option on that stock
The put provides insurance against price declines below the strike price. Maximum loss is limited to the stock price minus the strike price plus the premium paid.
Collar
A collar combines:
- Long 100 shares of stock
- Long 1 put option (downside protection)
- Short 1 call option (finances the put)
The call sale generates premium that partially or fully offsets the put cost. In a "zero-cost collar," the call premium equals the put premium.
Strategy Comparison
| Feature | Protective Put | Collar |
|---|---|---|
| Components | Long stock + long put | Long stock + long put + short call |
| Cost | Net debit (put premium) | Net debit, credit, or zero |
| Downside protection | Yes (at strike) | Yes (at put strike) |
| Upside potential | Unlimited | Capped at call strike |
| Break-even | Stock price + put premium | Varies by structure |
How It Works in Practice
Protective Put Mechanics
Position Setup:
- Own 100 shares of XYZ at $100
- Buy 1 XYZ $95 put for $3.00 (pay $300)
Greeks Profile (Put Leg):
- Delta: -0.30 (reduces net position delta to 0.70)
- Theta: -$0.05 per day (time decay works against you)
Payoff Analysis:
| Stock Price at Expiration | Stock Value | Put Value | Total Value | Net P/L |
|---|---|---|---|---|
| $80 | $8,000 | $1,500 | $9,500 | -$800 |
| $90 | $9,000 | $500 | $9,500 | -$800 |
| $95 | $9,500 | $0 | $9,500 | -$800 |
| $100 | $10,000 | $0 | $10,000 | -$300 |
| $110 | $11,000 | $0 | $11,000 | +$700 |
Maximum loss: ($100 - $95 + $3) × 100 = $800 Breakeven: $100 + $3 = $103
Collar Mechanics
Position Setup:
- Own 100 shares of XYZ at $100
- Buy 1 XYZ $95 put for $3.00 (pay $300)
- Sell 1 XYZ $110 call for $2.00 (receive $200)
Net cost: $3.00 - $2.00 = $1.00 ($100)
Greeks Profile (Net Options Position):
- Delta: -0.30 (put) + 0.20 (short call) = -0.10
- Net position delta: 1.00 - 0.10 = 0.90
- Theta: -$0.05 (put) + $0.03 (call) = -$0.02 per day
Payoff Analysis:
| Stock Price at Expiration | Stock Value | Put Value | Call Value | Total Value | Net P/L |
|---|---|---|---|---|---|
| $80 | $8,000 | $1,500 | $0 | $9,500 | -$600 |
| $95 | $9,500 | $0 | $0 | $9,500 | -$600 |
| $100 | $10,000 | $0 | $0 | $10,000 | -$100 |
| $110 | $11,000 | $0 | $0 | $11,000 | +$900 |
| $120 | $11,000 | $0 | -$1,000 | $10,000 | +$900 |
Maximum loss: ($100 - $95 + $1) × 100 = $600 Maximum gain: ($110 - $100 - $1) × 100 = $900 Breakeven: $100 + $1 = $101
Worked Example
Protective Put for Earnings Protection
You own 300 shares of ABC at $80, purchased for $24,000. Earnings are in two weeks, and you want to protect against a possible 15% drop.
Trade:
- Buy 3 ABC $75 puts, 21 days to expiration
- Premium: $2.50 per share ($750 total)
- Put delta: -0.35 per contract
- Put theta: -$0.08 per contract per day
Analysis:
| Metric | Value |
|---|---|
| Protection level | $75 (6.25% below current) |
| Maximum loss | ($80 - $75 + $2.50) × 300 = $2,250 |
| Cost of protection | $750 / $24,000 = 3.1% |
| Breakeven | $80 + $2.50 = $82.50 |
Outcome Scenarios:
-
Earnings miss, ABC drops to $65: Puts worth $10 each ($3,000 total). Stock loss: $4,500. Put gain: $3,000 - $750 = $2,250. Net loss: $2,250 vs. $4,500 without protection.
-
Earnings beat, ABC rises to $95: Puts expire worthless. Stock gain: $4,500. Net gain: $4,500 - $750 = $3,750.
-
Earnings in-line, ABC flat at $80: Puts expire worthless. Net loss: $750 (cost of protection).
Collar for Long-Term Holding
You own 500 shares of DEF at $50 with large unrealized gains. You want protection through year-end but don't want to spend cash on puts.
Trade:
- Buy 5 DEF $45 puts at $2.00 (pay $1,000)
- Sell 5 DEF $60 calls at $2.50 (receive $1,250)
- Net credit: $250
Analysis:
| Metric | Value |
|---|---|
| Downside protection | $45 (10% below current) |
| Upside cap | $60 (20% above current) |
| Net premium | +$250 (credit) |
| Maximum loss | ($50 - $45) × 500 - $250 = $2,250 |
| Maximum gain | ($60 - $50) × 500 + $250 = $5,250 |
This "credit collar" pays you to limit your range of outcomes. If DEF stays between $45 and $60, you keep the $250 credit and your shares.
Risks, Limitations, and Tradeoffs
Cost of Protection
Protective puts cost money, reducing returns in flat or rising markets. In the example above, the 3.1% cost of protection requires the stock to rise 3.1% just to break even.
Capped Upside (Collars)
Selling the call limits participation in rallies. If the stock jumps 30%, you only capture gains up to the call strike. This opportunity cost can be substantial in strong trends.
Time Decay
Long puts experience time decay. If the stock doesn't decline, the put loses value daily, eroding the protection's value. Collars partially offset this with the short call's positive theta.
Strike Selection Tradeoffs
| Put Strike | Cost | Protection Level |
|---|---|---|
| ATM ($100) | High | Maximum protection |
| 5% OTM ($95) | Moderate | After 5% loss |
| 10% OTM ($90) | Low | After 10% loss |
Cheaper puts provide less protection, cheaper calls cap upside sooner.
Common Pitfalls
-
Paying too much for protection: ATM puts are expensive. Consider OTM puts for catastrophic protection only.
-
Selling calls too close to current price: Limits upside unnecessarily for modest premium.
-
Ignoring expiration alignment: Ensure protection covers the risk period (earnings, macro events).
-
Treating collars as free: Zero-cost collars have opportunity cost—you're paying with capped upside.
-
Rolling indefinitely: Continuous rolling can accumulate significant costs over time.
Checklist for Hedging Strategies
- Define the specific risk you're hedging (earnings, market crash, specific decline level)
- Calculate cost of protection as percentage of position value
- Determine acceptable maximum loss with protection in place
- For collars, verify you're comfortable with the upside cap
- Check that expiration covers the full risk period
- Assess put delta to understand reduced participation in rallies
- Monitor theta decay if holding through time
- Plan exit strategy: hold to expiration, roll, or close early
Next Steps
For directional strategies with defined risk and reward, see Vertical Spreads: Bull and Bear Structures. Vertical spreads offer cost-efficient ways to express directional views.
For background on income strategies that complement protective positions, review Covered Calls and Cash-Secured Puts.