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Collar Options Trading Strategy Explained

Published on Wednesday, April 18, 2018 | Modified on Wednesday, June 5, 2019

Collar

Collar Options Strategy

Strategy LevelAdvance
Instruments TradedCall + Put + Underlying
Number of Positions3
Market ViewBullish
Risk ProfileLimited
Reward ProfileLimited
Breakeven PointPrice of Features - Call Premium + Put Premium

A Collar is similar to Covered Call but involves another position of buying a Put Option to cover the fall in the price of the underlying. It involves buying an ATM Put Option & selling an OTM Call Option of the underlying asset. It is a low risk strategy since the Put Option minimizes the downside risk. However, the rewards are also limited and is perfect for conservatively Bullish market view.

Suppose you are holding shares of SBI currently trading at Rs 250. You can deploy a collar strategy by selling a Call Option of strike price Rs 300 while at the same time purchasing a Rs 200 strike price Put option. If the price rises to Rs 300, your benefit from increase in value of your holdings and you will lose net premiums. If the price falls to Rs 200, you will lose value of your holdings but will benefit from exercising the Put option.

When to use Collar strategy?

The Collar strategy is perfect if you're Bullish for the underlying you're holding but are concerned with risk and want to protect your losses.

Example

Suppose you are holding ULTRATECH cements, currently trading at Rs 4780, or plan to buy it expecting a rise in its price in the near future. You also want to protect yourself from losses in case the stock moves downwards. In such a scenario, you can use the Collar strategy by selling a Call at Rs 5000 for a premium of Rs 40 and simultaneously buying a Put at Rs 4700 for a premium of Rs 30.

Current Trading Price of ULTRATECHRs 4780
Option Lot Size75
Call Option Strike PriceRs 5000
Premium ReceivedRs 40
Put Option Strike PriceRs 4700
Premium PaidRs 30
Net PremiumRs 10
Break Even Point
(Price of Underlying - Call Premium + Put Premium)
Rs 4770

Scenario 1: Price of ULTRATECH rises to Rs 5100

You can sell the stock or your holding will gain higher on paper value at Rs 5000. If sold, your profit will be Rs 220 (Rs 5000 – Rs 4780). When the net premium received of Rs 10 is factored in, your profit increases to Rs 230. The Put option will be worthless on expiry. Call option will be exercised and you have to pay Rs 100.

So net profit for you will be: Rs 220 + Rs 10- Rs 100 = Rs 130

Scenario 2: Price of ULTRATECH falls to Rs 4600

Your holdings will lose value on paper by Rs 180. You can exercise the Put option and earn Rs 100. The Call Option will be worthless on expiry. When the net premium received of Rs 10 is factored in, your loss will be: - Rs 180 + Rs 100 + Rs 12 = Rs 68

Collar Option Strategy Payoff Schedule
Closing Price of UltratechShort Call Option PayoffLong Put Option PayoffUltratech PayoffNet Payoff
4500300012750-21000-5250
460030005250-13500-5250
470030002250-6000-750
47703000-2250-7500
49003000-225090009750
50003000-22501650017250
5100-4500-22502400017250
5200-12000-22503150017250
collar strategy example nifty

Market View - Bullish

When you are of the view that the price of the underlying will move up but also want to protect the downside.

Actions

  • Buy Underlying
  • Buy 1 ATM Put Option
  • Sell 1 OTM Call Option

Breakeven Point

Price of Features - Call Premium + Put Premium

Risk Profile of Collar

Limited

You will incur maximum losses when price of the underlying is less than the strike price of the Put Option.

Max Loss = Purchase Price of Underlying - Strike Price of Long Put - Net Premium Received

Reward Profile of Collar

Limited

You will incur maximum profit when price of underlying is greater than the strike price of call option.

Max Profit = Strike Price of Short Call - Purchase Price of Underlying + Net Premium Received

Max Profit Scenario of Collar

Underlying goes up and Call option exercised

Max Loss Scenario of Collar

Underlying goes down and Put option exercised

Advantage of Collar

It protects the losses on underlying asset.

Disadvantage of Collar

The profit is limited

Simillar Strategies

Covered Put Bull, Call Spread, Bull Put Spread

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