What is a Collar option Strategy? When to use it?
- Asked By
- Updated On:07-Mar-2021
- Replies:2
Short Answer
A collar option strategy is a multi-leg option strategy that involves an existing long position in any security in the Equity or Futures market and buying an OTM (Out Of the Money) Put option and selling an OTM Call option in order to hedge the existing long position from any short term bearishness. The overall Profit and loss are capped in this strategy and this strategy is implemented when the overall outlook of the underlying asset is bearish.
Detailed Answer
Collar Option Strategy-
A collar strategy can be called a hybrid strategy as it involves taking a position both in the Cash as well as the Futures & options market. In a collar strategy, an investor/trader goes Long (Buys) an Asset from the cash or Futures market and buys an OTM (Out Of The Money) Put option as well as sells an OTM Call option.
In this way the downside of the particular asset is limited as if the price of the asset falls, the Put premiums will increase as well as the premiums of Sold call options will also decrease writing off the loss faced of the underlying asset.
When to use it-
A collar strategy is used as a hedge for long-term positions. When the long-term view of an asset is bullish but to protect it from the immediate downside, a Collar strategy is used. It can be used when a trader/Investor already has a long position in any particular asset which he wants to hedge and the outlook for that particular asset is bearish.
To implement a Collar strategy the following options have to be executed-
Existing Long position in ‘X’
- Buy 1 OTM (Out of The Money) Put option.
- Sell 1 OTM (Out of The Money) Call option.
In this way, a Collar strategy is implemented. A Zero Cost Collar can also be implemented, when the Net credit received from Selling the Call Option is used to buy an OTM Put option. In this way, no additional premium is paid for this strategy other than the span margin.
Let’s see how a collar strategy works-
Let's assume I already have a long position in Infosys for the long-term. The price has already increased by 10% but I don’t have any intention to sell the stock to realize those gains but I intend to protect those gains as the overall outlook for the stock appears to be bearish in the short term. In this case, I can implement a Collar strategy buy the following steps-
- Sell 1 OTM Call option of Infosys.
- Buy 1 OTM Put option of Infosys.
Now if the price of Infosys drops, I will face some losses in the existing long positions buy the Premium of the Put option will increase as well as the premium of the Call option will decrease. This will offset the losses faced in the Stock in my holding.
This is the payoff graph after implementing this Collar strategy on Infosys.
As seen above the profit and losses are capped till this strategy is in implementation hence even if the stock falls by a substantial margin then also there will be a limited loss and vice-versa.
Ask Your Query for FREE, Get quick answers from our FINTRAKK community!
Discussion (1)
Opstra Definedge is a platform that provides many tools and features to Derivative traders. Both Options as well as Future traders can make use of this platform. Some of the primary tools of Opstra are the Strategy Builder, IV (Implied Volatility) chart, Options Backtesting, Options Simulator, and many more. The Options Strategy Builder is one of the most intensively used tools on the platform.
If you're looking for a straightforward and comprehensive take on options trading, then Sensibull should do the job perfectly. However, if you're and expert and want more complex trading tools, then Opstra is the one to choose.
Options trading can be done in diverse ways. You can trade Options in unhedged or Naked positions as well as use multi-leg strategies to limit the losses. An endless combination of options can be used to put together a strategy. This can get complex sometimes. But many simple Option strategies can be used by Beginners. More of such strategies are discussed here.
Public Provident Fund Scheme is a saving scheme that comes with tax benefits. Ministry of Finance introduced this scheme in the year 1968. The main objective of PPF is to encourage general people to mobilize their small savings. The interest offered on these schemes are not taxable. Precisely, PPF is an investment with non-taxable returns.
Sensibull is an online Options trading platform that provides various Analysis tools that can be used to have a better understanding of the Options as well as to create and deploy various Option Trading Strategies that can be used by Investors & traders to Speculate as well as Hedge their existing portfolio. The Option Chain is an important feature of Sensibull. It is discussed in detail below.
Option Selling requires large capital. Due to this many small retail traders resort to option buying where the margin money required is very less. Although with various strategies you can reduce your overall risk and margin required in Options selling. Know more about how much money is required to start option selling. The difference in the margin money required for selling a naked Option vs Selling a Hedged Option here.
Options Trading as a trend is on the rise these days and is gathering more Retail attention. Due to this, the Option Trading platforms which provide tools for options traders are equally in high demand. Quantsapp and Sensibull are two of the prominent players in this field. Identify what are the differences, similarities, and which one to choose among the two.
FD vs Mutual Fund vs Real Estate Investment has its advantages in terms of how much you invest and your investing period. Longer the period, higher the returns.
Opstra Options Strategy builder is a platform for Options and Futures traders. It provides many tools for trading derivatives, Some of these include Options Simulator, Options backtesting, IV (Implied Volatility) Chart, Option Chain analysis, and much more. Both beginners, as well as advanced traders, can use this platform as it offers all the necessary features for both these groups.
Trading in India is completely safe as all the online brokers are registered by SEBI, which is the regulating body that regulates all the trading activities in the country. Apart from this, there are certain external risks involved in trading like Market Risks, Volatility risks, and over-leveraging, etc. These types of risks can be minimised to some extent by hedging but cannot be eliminated completely.
Harshil Patel
Collar option strategy is a unique way of safeguarding your intermediate short-term losses provided you have gone long on the same stock. It's where making money in a short time frame si feasible. But it does require sufficient capital and there is a higher risk involved provided your buying of CE and PE contracts arent in sync.