Building a Put-Spread Collar

A standard collar buys a put for protection and sells a call to help pay for it. But puts far below the current price are still not cheap, because the market prices in the chance of large moves too. An investor who wants to spend less on the put, and is willing to accept that a true crash won't be fully covered, can buy a put spread instead of a single put.

That is a put-spread collar: the call sale stays the same, but the protective put is replaced with a bought put minus a further-out-of-the-money put sold against it. The investor gives up protection below the second strike in exchange for a cheaper hedge overall.

The four legs

Starting from stock already owned, the structure adds three options:

1. Sell a call above the current price (as in a plain collar) — caps the upside, funds the hedge.
2. Buy a put below the current price — the main floor, where protection starts.
3. Sell a put further below that — reduces the cost of leg 2, but reopens losses below this lower strike.

Worked example

Stock trades at $100. A standard collar buys a $90 put and sells a $110 call, net cost roughly $1.50 per share. A put-spread collar instead buys the $90 put and sells an $80 put, while keeping the same $110 call.

• The $90 put alone might cost $3.00.
• Selling the $80 put brings in $1.20.
• Net put cost: $3.00 − $1.20 = $1.80, versus $3.00 for the single put — cheaper protection, but only down to $80.
• Combined with the $110 call sold for $1.50, total hedge cost: $1.80 − $1.50 = $0.30 per share, versus roughly $1.50 for the plain collar.

If the stock falls to $75, the plain collar's owner is made whole down to $90 with no further loss. The put-spread collar's owner is also made whole down to $90, but below $80 the loss resumes — at $75 they are exposed to the last $5 of the drop below $80, a loss the plain collar would have prevented.

What this means in practice

Put-spread collars are common in structured-note and defined-outcome products because they let issuers advertise a lower cost of protection, and in practice most drawdowns are moderate rather than catastrophic, so the gap the strategy leaves uncovered is rarely tested. But it is precisely in the tail event the strategy is least protected against that the missing coverage matters most — the strategy is cheaper exactly because it does not insure the scenario investors fear most.