Collar Strategy
A collar is a risk-management options strategy in which an investor who holds an underlying stock purchases a protective put to limit downside and simultaneously writes a covered call to offset the put's cost, confining the portfolio's value within a defined range.
The collar strategy was most commonly used by investors who held a significant long stock position — often acquired through an ESOP (Employee Stock Ownership Plan) or a long-term investment — and wanted downside protection without selling the underlying. By purchasing an out-of-the-money put and writing an out-of-the-money call on the same stock, the investor effectively created a band within which the stock's value would be retained. The written call premium reduced or fully offset the cost of the put, sometimes making the collar a zero-cost or near-zero-cost structure.
In the Indian context, collars were particularly relevant for employees who received large ESOPs in technology, banking, or pharmaceutical companies listed on NSE. An employee holding 1,000 shares of an IT company at an average cost of Rs 3,000 might purchase a 2,800 put and write a 3,300 call. If the stock fell to Rs 2,400, the put provided the right to sell at Rs 2,800, limiting the loss to Rs 200 per share. If the stock rallied to Rs 3,600, the written call obligated the employee to deliver shares at Rs 3,300, capping the upside at Rs 300 per share above the purchase price.
The key trade-off in a collar was the cap on upside gains. Unlike a protective put alone, which preserved full participation in an upward move, the collar sacrificed appreciation above the call strike. This made collars appropriate when the primary goal was capital preservation rather than participation in further appreciation — for instance, in the period immediately preceding a major liquidity event such as a lock-up expiry or a planned divestiture.
From a regulatory standpoint, collars on individual stocks were subject to SEBI's physical settlement mandate for stock derivatives that was phased in between 2018 and 2020. This meant that at expiry, the short call could result in delivery obligations if exercised, and traders had to ensure the underlying shares were available in their demat account to fulfil delivery. Failure to deliver resulted in auction penalties, which could be substantially higher than the original collar's premium income.
Tax treatment of a collar also required attention. The written call premium was treated as income in the year received for those not engaged in derivatives trading as a business, while the put premium was treated as a cost. Guidance from tax professionals was advisable for investors using collars extensively, given the evolving interpretations of F&O taxation by Indian tax authorities.