A collar is a name given to an investment strategy that uses options in order to limit the range of possible positive or negative returns on an investment in an asset to a specific range. For having this done, an investor by whom an asset is owned simultaneously buys a put option and sells (writes) a call option on the same asset. It is needed that the strike price on the call should be above the strike price for the put, and the expiration dates should be the same.
After that the investor has established the portfolio in this manner, the market value of the portfolio will be between the strike price on the call and the strike price on the put. Thus doing this possible gains and losses (the value of the portfolio minus the cost of acquiring it) are confined within a specified range.
Example
Let us consider an investor by whom one share of a stock is owned with a current price of $5. A collar could be constructed by an investor by buying one put with a strike price of $3 and selling one call with a strike price of $7. It will be ensured by the collar that the gain on the portfolio will be no higher than $2 and the loss will be no worse than $2 (before deducting the net cost of the put option, i.e., the cost of the put option minus what is received for selling the call option).
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