Which of the following best explains the function of an Option Collar?

An Option Collar is a risk management strategy that involves holding a long position in an underlying asset while simultaneously utilizing options to mitigate potential losses. Specifically, this involves buying a protective put option to hedge against downside risk and simultaneously selling a call option to cap the potential upside of the investment.

By implementing an Option Collar, an investor can protect their investment from significant losses, thus mitigating downside risk. However, they also accept that their profit potential is limited, as gains beyond the strike price of the call option will not be realized. This trade-off is crucial in understanding the function of an Option Collar, as it provides a safety net against losses while also defining the bounds of potential profit, which aligns precisely with the answer provided.

This strategy is particularly useful in volatile markets where an investor wants to protect their capital while remaining invested in the underlying asset.