A collar is a spread strategy used to protect unrealized profits on a position already established. To this end, an investor purchases a protective put on a long equity position, and offsets the cost of that put by writing a call that is covered by the long equity position. In most cases, both the purchased put (long put) and the sold call (short call) are out-of-the-money. If the call the investor sells is less expensive than the put he buys, the premium he receives will be less than the premium he pays, thus, establishing a debit collar.
For example, consider an investor who purchased 100 shares of company XYZ at $50 two years ago, and the current share price is $100. If the investor purchases a 90 put, he will have the right to sell those shares at $90 (per share) before expiration, locking in a $40 on each share, or a total of $4,000. Suppose this put costs $500, or $5 per share. Assume also that the investor sells a 110 call with the same expiration month, and receives $450 in premium, or $4.5 per share.
| Put price paid | – $500 |
| Call price received | +$450 |
| Net profit | – $50 |
The negative net profit (i.e., net cost) means the position is a debit collar.
