What are the risks of using a protective collar?
Investors will use a protective collar to hedge a position to limit downside risk at a minimal cost. However, it's not a riskless strategy. The strategy helps cushion the blow of a steep price decline, protecting an investor's losses below the purchased put strike price.
For example, if an investor bought 100 shares of a company at $100 a share and then bought a $95 put option as part of a protective collar on that stock, the trade would limit their losses to $5 per share (i.e., the difference between the stock's price and the put strike price). If the stock fell below $95, the investor could sell the put option for a profit to cover any loss below the strike price.