Collars vs. Covered Calls: Why Active Hedging Outperforms in 2025's Volatile Markets

The first half of 2025 has been a masterclass in market volatility. The Cboe Volatility Index (VIX) spiked above 50 in early April—the highest since the 2020 pandemic—after aggressive U.S. tariff announcements triggered a 12.9% S&P 500 selloff. In this environment, income-focused investors face a critical question: How to generate steady returns without sacrificing downside protection? The answer, as 2025's data shows, lies in moving beyond passive covered call ETFs and adopting active options collars.

The Volatility Drag Problem with Covered Call ETFs

Covered call ETFs like SPYI (S&P 500 covered call) and QQQI (Nasdaq-100 covered call) have long been marketed as “set-and-forget” income vehicles. They work by selling call options against an underlying index to generate premium income. But in volatile markets, this strategy has a fatal flaw: it caps upside while failing to protect against significant downside.

Take the April 2025 tariff-driven selloff. The S&P 500 dropped 12.9% in eight days—the worst drawdown since 2020. While the index rebounded quickly, covered call ETFs faced a double whammy. Their long equity exposure was hit hard, and the sold calls offered no cushion. Worse, the premiums collected earlier in the year paled against the capital losses. By contrast, a collar strategy—which pairs the sold calls with a purchased put—would have shielded investors from the worst of the drop.

Collars: Customizable Protection for Volatile Markets

A collar involves three components:
1. A long position in the underlying asset (e.g., SPY).
2. A sold call option (generating income).
3. A purchased put option (providing downside protection).

This structure allows investors to tailor risk parameters:
- Downside floor: The put strike determines the maximum loss.
- Upside ceiling: The call strike caps gains.
- Net cost: The premium from selling the call offsets the put's cost, often resulting in a zero or low net expense.

In 2025's tariff-driven volatility, collars could have been dynamically adjusted. For example, as the VIX spiked, investors could buy deeper out-of-the-money puts to widen the downside buffer, while selling further-out calls to maintain income. This adaptability is impossible with fixed ETF structures like SPYI, which cannot adjust their hedging parameters in real time.

Tax Efficiency: A Draw for Both Strategies, but Not the Decider

Both collars and covered calls benefit from Section 1256 contract treatment, which splits gains into 60% long-term and 40% short-term capital gains. This avoids the punitive ordinary income tax rates applied to traditional bonds. However, tax efficiency alone doesn't resolve the core issue: covered calls sacrifice growth potential without adequate downside defense.

Consider the Nasdaq's 18% surge in Q2 2025, driven by AI stocks. A collar strategy could have participated in this upside by choosing call strikes at, say, +15% while maintaining a put floor. A covered call ETF like QQQI, however, would have sold calls at a fixed strike, capping gains and leaving investors exposed to the selloffs.

The Active Edge: Why Collars Win in 2025

The key advantage of collars isn't just better risk-adjusted returns—it's the ability to respond to shifting market dynamics. In early 2025, geopolitical risks (e.g., Middle East tensions) and tariff uncertainty created episodic volatility. Active collar managers could:
- Increase put coverage before earnings or policy announcements.
- Shift call strikes based on implied volatility trends.
- Leverage correlation shifts (e.g., S&P 500-Treasury yield linkages) to optimize hedges.

Passive covered call ETFs, by contrast, are stuck with static strategies. Their fixed put-buying (if any) and call-selling parameters can't adapt to sudden spikes in volatility like the April 2025 tariff shock.

Investment Takeaways for 2025

1. Avoid “Passive” Covered Calls in Volatile Markets: ETFs like SPYI and QQQI are best suited for steady markets. In environments with sharp drawdowns or regime shifts (e.g., trade wars), their lack of customizable downside protection creates hidden risk.
2. Build Collars Directly or Use Hedged ETFs: Consider ETFs like SPYH (S&P 500 collar) or CSHI (T-bill + S&P put spread), which embed collar mechanics. However, direct portfolio implementation allows finer control over strike prices and expiration dates.
3. Monitor the VIX and Policy Risks: With the VIX still elevated at 30+ (vs. 15-20 historically), active hedging is a must.

Final Verdict

In 2025's market, income investors face a stark choice: sacrifice growth for safety, or sacrifice safety for growth. Covered call ETFs pick the latter—they cap upside without adequate downside protection. Collars, by contrast, let you have both. As geopolitical risks and tariff-driven volatility persist, the edge clearly belongs to active hedging strategies.

The bottom line: In volatile markets, customization beats passivity every time.