Collar Option Strategy Collar Option Strategy Collar Option Strategy

Collar Option Strategy

Danny Khoo

Sales Trader

Summary:  Collar is an option strategy used by investors and traders to reduce portfolio volatility through a combination selling and buying of options. This is done by limiting both upside and downside of an underlying asset over the short term. A collar position is created by combining the protective put and covered call option strategy at the same time.


What is the Collar Option Strategy?

Collar Position = Underlying Stock + Long Out of The Money
Put Option + Short Out of The Money Call Option

The strategy is typically used by investors who are concerned about the downside risks of their holdings in the short term. The investors sell an out of the money call option while simultaneously buying an out of the money put option on the same underlying stock thereby capping the upside in order to fund the premium to buy downside protection.

Selling an out of the money call option involves choosing a call option with a strike higher than the current trading price of the stock ( Stock trading at $170, call strike at $180). Buying an out of the money put option involves choosing a put option with a strike below the current trading price of the stock (stock trading at $170, put strike at $160).

Why use the Collar Option Strategy?
Collar strategy is an alternative to traders who are looking to hedge the downside risks of the stocks in the short term but have no intention to sell the stock for the fear of short-term risks. Therefore they are comfortable to commit to capping their profits by selling the call option and using that premium to buy protection against downside risks.

Payoff Diagram

Legend
Kp = Strike price for OTM put option
Kc = Strike price for OTM call option

This is the pay-off diagram for using a collar option strategy. The trader/investor would have limited losses when the price of the stock falls below the put option’s strike price of Kp. However, if the stock rises above the call option’s strike price of Kc, the trader/investor would have limited upside.

Example
A client owns 100 shares in Apple trading at the price of $170. He sells 1 call option at strike $180 with a 1 month expiry. At the same time, he also buys a put option at strike of $160. The premium received from selling the call option is $3 while the cost of buying the put option is $1. In this example, Apple call options are more expensive than put options (positive skew), but the skew could also go the other way or stay flat depending on the prevailing interest rates and market sentiment.

You would receive a net premium of $2 credit per share with this structure. If you wish to make this trade a zero-cost strategy, you can afford to buy a put option with a higher strike that cost up to $3. This would offer greater downside protection.

Payoff Diagram 2

Max gain per share is when Apple rises to $180
$3 (premium received from selling call option) - $1 (premium paid for buying put option) + $10 ( gain from owning Apple shares) = $12

Breakeven point
$170 + $3 (premium received from selling call option) - $1 (premium paid for buying put option) = $168

Max loss per share if Apple falls below $160
$3 (premium received from selling call option) - $1 (premium paid for buying put option) - $10 ( loss from owning Apple shares) = -$8

Scenario 1 – Apple trades to $175
P&L = $3 (premium received from selling call option) - $1 (premium paid for buying put option) + $5 ( gain from owning Apple shares) = $7

Scenario 2 – Apple trades to $165
P&L = $3 (premium received from selling call option) - $1 (premium paid for buying put option) - $5 ( Loss from owning Apple shares) = -$3

Uses of the Collar Option Strategy
The collar option strategy is yet another tactical option in a trader/investor’s toolkit to help hedge their positions in the portfolio over the short to medium term. If an investor holds a large position in a particular stock, they can construct a collar position to protect against short-term downside risks without letting go of the stock. The cost of purchasing the protective put option to hedge against the fall in price of the underlying asset can be offset from the sale of the covered call. If the cost of the put option is covered entirely by the sale of the call option, this can be called a zero-cost collar. If the cost of the put option is lower than the premium receive by the sale of the call option, then this works as a part hedge and part yield enhancement strategy.

As the collar options are more frequently used as a tactical strategy, a trader/investor has plenty of flexibility when employing this strategy and can choose to use this on some or all of their stock holdings in different market conditions.

Disclaimer

The Saxo Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-hk/legal/disclaimer/saxo-disclaimer)

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo or its affiliates.

Saxo Capital Markets HK Limited
19th Floor
Shanghai Commercial Bank Tower
12 Queen’s Road Central
Hong Kong

Contact Saxo

Select region

Hong Kong S.A.R
Hong Kong S.A.R

Saxo Capital Markets HK Limited (“Saxo”) is a company authorised and regulated by the Securities and Futures Commission of Hong Kong. Saxo holds a Type 1 Regulated Activity (Dealing in Securities); Type 2 Regulated Activity (Dealing in Futures Contract); Type 3 Regulated Activity (Leveraged Foreign Exchange Trading); Type 4 Regulated Activity (Advising on Securities) and Type 9 Regulated Activity (Asset Management) licenses (CE No. AVD061). Registered address: 19th Floor, Shanghai Commercial Bank Tower, 12 Queen’s Road Central, Hong Kong.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products may result in your losses exceeding your initial deposits. Saxo does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo does not take into account an individual’s needs, objectives or financial situation. Please click here to view the relevant risk disclosure statements.

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-hk/about-us/awards.

The information or the products and services referred to on this site may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and services offered on this website are not directed at, or intended for distribution to or use by, any person or entity residing in the United States and Japan. Please click here to view our full disclaimer.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc. Android is a trademark of Google Inc.