Put Spread Collar Defined
A good starting place for understanding a put-spread collar is a basic collar. The two are closely related. The put-spread collar is a variation of the collar, with more upside potential coupled with more downside risk.
A basic, traditional collar typically has three components:
- A long, buy-and-hold position in a market
- Long, out-of-the-money puts to protect on the downside
- Short, out-of-the-money calls to help pay for the puts
The put-spread collar is a variation to the traditional collar’s long equity + long put hedge + short call premium. It takes a fourth position, selling put options at a strike price some distance below the long hedge put option to generate additional monies to combine with the short call premium to cover the hedge costs.
The primary benefit to this approach versus a traditional collar is that the additional premium from the put option sale allows the manager to raise the strike price on the call and therefore raise the cap. The cost for the increased cap, however, is that the investor accept protection limited to the range between the long put (hedge) and the short put strikes during the collar term.
Profit and loss versus the market (S&P 500) is depicted in the following illustration. Notice that the hedge and short call strikes are more symmetric in their position relative to the current market level than the traditional collar’s positioning of these securities. Specifically, more upside is possible (2.5% in this case) due to the premium received from selling the put option (i.e. 20% OTM).
Source: Swan Global Investments