What is a Collar?
A collar is a financial strategy that involves using multiple options contracts to protect against significant losses while limiting gains. It is a combination of a protective put and covered call, with the goal of reducing risk exposure in a volatile market.
Types of Collars
- Zero-cost collar: This type of collar involves utilizing options to create a protective put and covered call without any initial cost.
- Costless collar: Similar to a zero-cost collar, this strategy involves using options to establish a protective put while also generating income through a covered call.
- Put spread collar: In this type of collar, an investor purchases a put option while simultaneously selling another put option with a lower strike price to offset the cost.
Collar Example
Let’s say an investor owns 100 shares of a stock trading at $50 per share. To protect against a potential downturn, the investor buys a put option with a strike price of $45 and sells a call option with a strike price of $55. This collar limits the investor’s losses if the stock price drops below $45 while capping their gains if the stock price rises above $55.
Case Study: Company XYZ
Company XYZ is a tech company that is experiencing high volatility in its stock price. To protect against potential losses, the company implements a zero-cost collar by purchasing a put option with a strike price of $80 and selling a call option with a strike price of $90. This collar allows Company XYZ to safeguard its investment while still participating in any potential upside.
Statistics
According to a study by the Options Industry Council, collars have been shown to reduce overall portfolio risk by 20% or more in turbulent market conditions. This risk-management strategy is increasingly popular among institutional investors looking to protect their assets in uncertain times.
