Option Strategies: Covered Call, Protective Put, Collar¶
One-line definition¶
The three standard ways a PM combines an existing stock position with one or two options to reshape its return profile — trade away some upside for income (covered call), pay for a downside floor (protective put), or fund the floor with the upside (collar).
Covered call (buy-write)¶
Own the stock, sell a call against it. Caps upside at the strike (plus premium collected); the premium provides a small cushion on the downside, but full downside risk below that cushion remains. Suits a neutral-to-moderately-bullish view from an investor willing to have the stock called away at the strike.
Protective put (married put)¶
Own the stock, buy a put against it. Unlimited upside remains; downside is floored at the strike (minus the put's cost). The put's premium is a direct drag on returns if the stock doesn't fall — functionally an insurance premium paid whether or not the "claim" is ever used.
Collar¶
Own the stock, buy a put (the floor) and sell a call (the ceiling) at the same expiry. The call premium collected offsets some or all of the put premium paid — a "zero-cost collar" is one sized so the two premiums exactly cancel. Trades away upside beyond the call strike in exchange for a floor below the put strike, cheaper (or free) compared to a bare protective put.
Why PMs care¶
These aren't three unrelated ideas — they're the same building block (an existing position plus a Black-Scholes-priced option, or two) applied with different objectives: income (covered call), pure insurance (protective put), or cheaper insurance funded by giving up some upside (collar). A PM overlay desk uses exactly this toolkit to adjust a portfolio's risk profile without transacting in the underlying itself — useful when the underlying position is large, illiquid, or has a tax or mandate reason not to be sold outright.
Why this isn't implemented in src/pm¶
Each strategy's payoff is a linear combination of a stock position and
one or two Black-Scholes-priced legs — pm.options.black_scholes_call_price
and black_scholes_put_price already price every leg involved; no new
pricing formula is needed. What a real implementation would add is
payoff-diagram and breakeven-point construction across a price grid,
which is a plotting/composition exercise on top of the existing pricing
functions rather than new financial math — left as a notebook exercise
(construct each strategy's payoff yourself from the two priced legs)
rather than a src/pm function, consistent with this repo's rule that a
new function earns its place by encoding a formula, not by composing
existing ones for display purposes.
Common mistakes¶
- describing a collar as "free" — a zero-cost collar has zero premium cost, not zero cost: the giveaway is the capped upside above the call strike, which has real value in a strong rally
- assuming a covered call is a pure income strategy with no risk — the written call limits upside, but the stock's full downside (beyond the small premium cushion) is still there
- forgetting time decay cuts the other way for a protective put than for a covered call: theta hurts the protective-put buyer (long the put) and helps the covered-call writer (short the call), for the same reasons covered in Black-Scholes and the Greeks