A zero-cost collar is an options strategy that limits both gains and losses on an investment at no net upfront cost.
A zero-cost collar is an options-based strategy used by investors to hedge a position in an underlying asset—typically a stock—by simultaneously purchasing a protective put and selling a covered call. The put option limits downside risk, while the call option caps upside potential. The premiums from buying the put and selling the call typically offset each other, resulting in little to no net cost. Investors use a zero-cost collar to provide a defined range of outcomes for their holdings. This strategy works particularly well when the investor wants to protect unrealized gains or secure a return over a particular timeframe while still holding the asset. The investor retains ownership of the underlying security, which is necessary to enter the collar. The key to a true zero-cost collar lies in selecting strike prices for the call and put such that their premiums cancel each other out. If the investor chooses a more expensive put or a cheaper call, the strategy may require a small net payment or credit.
Zero-cost collars offer a tax-advantaged mechanism to lock in gains without triggering capital gains taxes through an outright sale, which can be significantly beneficial for tax-sensitive family office structures. They provide structured downside protection, which can be critical in wealth preservation strategies and risk management frameworks when overseeing multi-generational capital pools. Additionally, they can be strategically timed around reporting cycles or estate planning milestones when being able to forecast asset value within a band is valuable. This derivative-based hedge allows family offices to maintain exposure to core equities while minimizing performance volatility on holdings that are material to the overall portfolio.
Suppose a family office owns 10,000 shares of a tech company trading at $100. To protect against a drop below $90 over the next 6 months, it buys a $90 put. To offset that cost, it sells a $110 call. The premiums are roughly equal, making the net cost nearly zero. As a result, the office is protected against losses below $90, but gives up gains beyond $110.
Zero-Cost Collar vs Covered Call
A covered call involves holding a long stock position and selling a call option to generate income, whereas a zero-cost collar includes both a sold call and a purchased put, offering downside protection. While the covered call only limits upside, the zero-cost collar limits both upside and downside, effectively creating a price band without paying for the hedge.
Is a zero-cost collar truly free?
While the strategy may have no net upfront cost in terms of option premiums, there are potential opportunity costs and costs related to implementation such as brokerage commissions or bid-ask spreads.
Can a zero-cost collar be used on any asset?
Zero-cost collars are generally used on publicly traded securities with high liquidity in options markets. Assets without a developed options market may not be suitable for this strategy.
Does implementing a zero-cost collar delay capital gains taxes?
Yes, it can. Since the strategy does not involve selling the underlying position, it allows investors to hedge price exposure without triggering a taxable event, unless the collar is considered a constructive sale under IRS rules.
