Collar Trading Strategy
1. Definition:
The collar strategy is an options Trading strategy that involves purchasing one put option contract while simultaneously selling one out-of-the-money (OTM) call option contract, where both contracts have the same quantity, and the put option's strike price is lower than the call option's strike price.
Typically, traders who employ the collar strategy already hold a long or short position in the underlying asset. Executing this strategy protects the returns on the underlying asset position and hedges against risk.
2. Profit Mechanism:
For buyers of this strategy, the return structure is similar to simply going long on the asset, such as in a perpetual contract, which offers potential leverage advantages. Additionally, returns between the put and call option strike prices are relatively stable, meaning traders do not incur additional gains or losses due to price fluctuations.
One use case is: if a trader expects higher volatility in the asset but the spot price will continue rising past the call option's expiration period, they can sell the put option and capture returns from the price difference between the two. Additionally, selling put options can also be used to lock in the cost of a short position on the asset, which is the exact opposite reasoning from the seller's perspective.
The seller's operations in this strategy are completely opposite to the buyer's. For sellers, they typically seek to lock in returns on long positions while allowing additional upside price movement. Sellers executing the collar strategy can ensure that the returns on early long positions will not fall below the put option's strike price, as the returns received from selling the put option will offset any losses incurred by the long asset.
Additionally, if the underlying price continues to rise modestly, traders can also earn additional returns before the price reaches the call option's strike price. This strategy provides traders with a certain degree of risk management room, reducing uncertainty without having to completely stop Trading.
3. Trading Details:
This strategy is more commonly applied when traders hold a relatively optimistic outlook on market conditions, commonly referred to as a bull market. It is important to note that the maximum profit of this strategy is unlimited, but the corresponding maximum loss is also unlimited.
Collar Strategy Price Chart
The collar strategy can be employed by traders in the following specific scenarios:
When a trader expects the underlying asset price to rise but cannot afford the cost of going long, the collar strategy can be adopted as it has lower costs. Of course, to reduce costs, the trader will forgo earning returns until the underlying asset price reaches a higher strike price.
Alternatively, when a trader has already shorted a certain underlying asset or holds a short contract position in that asset, and wishes to lock in returns, but the trader still wants to earn additional returns and is unwilling to take on more risk.
Executing this strategy requires the following conditions:
1) Both legs must have the same quantity, namely:
Buy 1 out-of-the-money (OTM) put option (Leg 1)
Sell 1 out-of-the-money (OTM) call option (Leg 2)
2) Both legs should have the same expiration date, but different strike prices
3) The net strategy price is as follows:
Long: Call option premium from Leg 1 (seller's quote) (low strike price) - Put option premium from Leg 2 (buyer's quote) (high strike price)
Short: Call option premium from Leg 2 (buyer's quote) (high strike price) - Put option premium from Leg 1 (seller's quote) (low strike price)
4) Margin rules:
The long call leg requires no margin, only payment of contract fees to purchase the contract.
The short put leg must meet full margin requirements, just as if selling a put option alone.
4. Specific Trading Examples:
Assuming the call option strike price is $30,000 and the put option strike price is $25,000
1, Scenario 1: Price rises significantly, call option is in-the-money (ITM). For example, if the underlying price rises to $35,000, then —
Leg 1 returns: Option fee paid = -$2,000
Leg 2 returns: Option fee received – (latest spot price – strike price) = $1,000 – ($35,000 – $30,000) = -$4,000
Total returns: -$2,000 – $4,000 = -$6,000
**2, Scenario 2: Price rises, **both call and put options are out-of-the-money (OTM). Assuming it is $29,000, then —
Leg 1 returns: Option fee paid = -$2,000
Leg 2 returns: Option fee received = -$1,000
Total returns: -$2,000 + $1,000 = -$1,000
Note: Total returns may be negative if the put option premium is higher than the call option premium
**3, Scenario 3: The underlying asset price falls to $20,000, **below the put option strike price, so the put option is in-the-money (ITM) —
Leg 1 returns: Option fee paid + (strike price – latest spot price) = -$1,000 + ($25,000 – $20,000) = $4,000
Leg 2 returns: Option fee received = $2,000
Total returns: $4,000 + $2,000 = $6,000
Disclaimer
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