Collar

A covered call is long stock plus a short call. It earns premium and caps the upside — but it leaves the downside open. If the stock collapses, the small premium barely helps.

A collar closes that gap. Add a long put. Now the position has:

• a ceiling — the short call caps the gain above its strike;
• a floor — the long put caps the loss below its strike.

The workbook describes it as an extension of the covered call: to put a floor under the downside, we go long a put option, which essentially eliminates the downside of the long underlying with short call (the synthetic short put).

The price of that protection is twofold. The put costs a premium, so maximum profit falls, and the break-even rises by the premium paid.

Three legs, same maturity:

Maximum profit = (call strike − stock price) + call premium − put premium.

Maximum loss = (stock price − put strike) − call premium + put premium.

Between the two strikes, the position behaves like the stock with a small net premium adjustment.

Max profit = (Call strike − Stock cost) + Call premium − Put premium
Max loss   = (Stock cost − Put strike) − Call premium + Put premium
Break-even = Stock cost − Call premium + Put premium

The workbook's collar (Chapter 5, section 5.2). Long stock at 1,590; short 1,600 call for premium 10; long 1,580 put for premium 7.

Price falls to 1,490 at maturity:

Long stock: −1,590 + 1,490        = −100
Short call: +10 (expires)         =  +10
Long put:   −7 + (1,580 − 1,490)  =  +83
Net                               =   −7

The covered call alone would have lost 90.

Price rises to 1,690 at maturity:

Long stock: −1,590 + 1,690        = +100
Short call: +10 − (1,690 − 1,600) =  −80
Long put:   −7 (expires)          =   −7
Net                               =  +13

The covered call alone would have made 20.

Loss is capped at 7, profit at 13. The covered call's break-even was 1,580; with the put it rises by the Rs 7 premium to 1,587.

Chapter 5, section 5.2 (Use of Options for Trading and Hedging), presents the collar immediately after the covered call and before the butterfly spread, with the payoff table reproduced above. Questions ask for the legs of a collar, its maximum loss or profit from a table, and what adding the put does to profit and break-even.

• A collar is long stock + short call + long put. Not long call, and not short put.
• The put lowers the maximum profit — 13 instead of 20 in the workbook's example.
• The put raises the break-even by its premium.
• The put is typically out of the money (strike below the stock price) to keep its cost small.
• The workbook calls a covered call a synthetic short put; the collar is what removes that short-put-like downside.