Markets can change direction before investors have time to react. A stock may look strong, supported by healthy earnings, good technical signals, and positive momentum. Yet an economic shock or market-wide sell-off can pull its price lower within hours. This leaves investors with a difficult choice: avoid the trade and miss a possible opportunity, or enter the position and accept the risk of a sharp fall.
Hedging can reduce this uncertainty, but protection also has a price. The simplest hedge is to buy a Put option against a stock or long futures position. A Put gives the holder the right to sell the underlying asset at a strike price. If the market declines, the Put can gain value and offset part of the loss on the stock or Future. If prices rise, the underlying position can produce a profit.
The problem appears when the market moves sideways. The Put premium loses value as time passes, a process known as time decay. After repeating this experience, traders often stop buying Puts to save money. That decision removes protection precisely when a sudden decline arrives. The search for a cheaper hedge, therefore, leads to the Collar strategy.
A Collar combines three positions: buy the stock or Future, buy a Put, and sell a Call. The Put is usually selected at or slightly below the market price. It establishes a floor beneath the position. The Call is sold at a strike near the trader's short-term upside target. Selling the Call brings in premium income, which helps pay for the Put.
Consider a stock trading at ₹1,000. An investor buys the stock, buys a ₹950 Put, and sells a ₹1,100 Call. Suppose the stock falls to ₹800. The stock loses ₹200, but the Put is now worth at least ₹150. The option offsets much of the decline below ₹950, limiting the damage. If the stock stays near ₹1,000, the Put gradually loses time value, but the Call premium helps reduce that cost. If the stock rises to ₹1,200, the Call may be exercised at ₹1,100. The investor still earns the planned upside, but gives up gains above the Call strike.