Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
Access both platforms from your single Saxo account.
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.
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.
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.
Latest Market Insights
Quarterly Outlook
-
-
Quarterly Outlook
Equity Outlook: Will lower rates lift all boats in equities?
Peter Garnry
Chief Investment Strategist
After a period of historically high equity index concentration driven by the 'Magnificent Seven' sto... -
Quarterly Outlook
FX Outlook: USD in limbo amid political and policy jitters
Charu Chanana
Chief Investment Strategist
As we enter the final quarter of 2024, currency markets are set for heightened turbulence due to US ... -
Quarterly Outlook
Macro Outlook: The US rate cut cycle has begun
Peter Garnry
Chief Investment Strategist
The Fed started the US rate cut cycle in Q3 and in this macro outlook we will explore how the rate c... -
Quarterly Outlook
Commodity Outlook: Gold and silver continue to shine bright
Ole Hansen
Head of Commodity Strategy
-
Quarterly Outlook
FX: Risk-on currencies to surge against havens
Charu Chanana
Chief Investment Strategist
Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperfo... -
Quarterly Outlook
Equities: Are we blowing bubbles again
Peter Garnry
Chief Investment Strategist
Explore key trends and opportunities in European equities and electrification theme as market dynami... -
Quarterly Outlook
Macro: Sandcastle economics
Peter Garnry
Chief Investment Strategist
Explore the "two-lane economy," European equities, energy commodities, and the impact of US fiscal p... -
Quarterly Outlook
Bonds: What to do until inflation stabilises
Althea Spinozzi
Head of Fixed Income Strategy
Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain ... -
Quarterly Outlook
Commodities: Energy and grains in focus as metals pause
Ole Hansen
Head of Commodity Strategy
Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities i...
Disclaimer
The Saxo Bank 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. This content is not intended to and does not change or expand on the execution-only service. 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 Bank 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 Bank 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 Bank 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 Bank 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 Bank 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-gb/legal/disclaimer/saxo-disclaimer)