Zero Cost Collar

What Is a Zero Cost Collar?

A zero cost collar is a form of options collar strategy to safeguard a trader's losses by purchasing call and put options that cancel each other out. The downside of this strategy is that profits are capped assuming the underlying resource's price increments.

Grasping Zero Cost Collar

A zero cost collar strategy includes the outlay of money on one half of the strategy offsetting the cost incurred by the other half. A protective options strategy is carried out after a long position in a stock that has encountered substantial gains. The investor buys a protective put and sells a covered call. Different names for this strategy incorporate zero cost options, equity risk inversions, and hedge coverings.

To execute a zero cost collar, the investor buys a out-of-the-money put option and all the while sells, or composes, an out-of-the-money call option with a similar expiration date.

For instance, if the underlying stock trades at $120 per share, the investor can buy a put option with a $115 strike price at $0.95 and sell a call with a $124 strike price for $0.95. In terms of dollars, the put will cost $0.95 x 100 shares for each contract = $95.00. The call will make a credit of $0.95 x 100 shares for every contract - the equivalent $95.00. Hence, the net cost of this trade is zero.

Utilizing the Zero Cost Collar

It isn't generally imaginable to execute this strategy as the premiums, or prices, of the puts and calls don't necessarily in every case match precisely. In this way, investors can conclude how close to a net cost of zero they need to get. Picking puts and calls that are out of the money by various amounts can bring about a net credit or net debit to the account.

The farther of-the-money the option is, the lower is its premium. Subsequently, to make a collar with just a negligible cost, the investor can pick a call option that is further away of the money than the separate put option is. In the above model, that could be a strike price of $125.

To make a collar with a small credit to the account, investors do the inverse — pick a put option that is further away of the money than the particular call. In the model, that could be a strike price of $114.

At the expiration of the options, the maximum loss would be the value of the stock at the lower strike price, even assuming that the underlying stock price fell pointedly. The maximum gain would be the value of the stock at the higher strike, even assuming the underlying stock climbed pointedly. In the event that the stock closed inside the strike prices, there would be no effect on its value.

In the event that the collar brought about a net cost, or debit, the profit would be decreased by that outlay. On the off chance that the collar brought about a net credit, that amount is added to the total profit.

Features

• It may not generally find success in light of the fact that premiums or prices of various types of options don't necessarily in all cases match.
• A zero cost collar strategy is utilized to hedge against volatility in an underlying resource's prices.
• A zero cost collar strategy includes the purchase of call and put options that place a cap and floor on profits and losses for the derivative.