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At the top, trade 'Collar ' to fight cynicism: Shubham Agarwal

Collar is defined as a strategy where one is Long on Future(Underlying) at the same time Long on Out of the Money(Lower) Put and Short of Out of the Money Call(Higher).

SHUBHAM AGARWAL | 25-Jul-20
Reading Time: 3 minutes

Indices are making newer highs adding every next Kilo (1,000 points) faster than preceding. Such are the moves which have bitter memories of being heavily leveraged and getting stung by massive dents due to reversals.

But today, let us not talk about those dents or reversals. Let us focus on techniques to turn such dents or reversal if and when they come is absolutely immaterial. With markets making newer highs and with a sense of cynicism setting in, participation is generally too low or post a big missed move it is very high just to make up for the lost opportunity.

Either one of the cases lacks rationality. Hence, let us understand a slight change of approach and get the remedy of the said cynicism into the trade itself so that we do not under-trade or over-trade every upcoming stride.

Introducing Collar, a strategy generally ignored for being a bit more defensive but has its own flexibility and advantages in terms of managing profitability at the same time containing drawdowns.

Collar is defined as a strategy where one is long on Future (Underlying) at the same time Long on Out of the Money (Lower) Put and Short on Out of the Money Call (Higher).

Do not despair looking at the 3 legs of the trade as each one of them has a utility and gift of peace of mind with it. Let us understand the benefit of each one of them one by one.

Long Future (Underlying): Long position is straight forward, where one is positively oriented with the price rise. In a rising market, this is what generally one is expected to do with a stop loss and profit-taking objectives decided in advance and executed as when they come.

But instead of a Stop Loss and Target, we will add two more legs

Long Out of the Money (Lower) Put: This leg is added to avoid being worried about the stop loss. Since one is long on a Put the losses on the Long Underlying will get compensated just in case of expiry below the strike price of Put.

For an Intermediate position term, this would be a good wat to define the trade and leave it to itself. But many would keep this position as a drawdown protection mechanism. Here the Put will rise in value but that would just compensate a part of the Underlying loss during expiry.

The monetary loss stop losses are adopted here. If the losses in Underlying after being compensated by Long Put Profits and Short Call Profits are exceeding a pre-decided loss figure, one would get rid of the entire trade.

On the other hand, if the underlying moves up but not high enough to book profits one may shift the Put strike upwards to lock profits on the underlying.

Short Out of the Money (Higher) Call: This leg is an addition just to fund the cost of the Put bought. Considering the fact that there is already a massive move put in place by the underlying, one is always working with a possibility of a pullback or digestive consolidation.

This is an apt position for two out of three scenarios viz. rise, pull back or consolidation. Yes, it minimizes the profits if the underlying rallies immediately.

One could translate such expectation by going farther in choosing Call Strike when an immediate move is expected and vice-versa.

In a nutshell, Collar is one Strategy that comes in handy at the cost of sone profits when the Rise is already in place but one still wants to trade with peace of mind without asking the cynical question “Haven’t we risen enough?

The author is CEO & Head of Research at Quantsapp.

Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.

Learn and read more about futures contract from Quantsapp classroom which has been curated for understanding of futures market from scratch, to enable option traders grasp the concepts practically and apply them in a data-driven trading approach.

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SHUBHAM AGARWAL is a CEO & Head of Research at Quantsapp Pvt. Ltd. He has been into many major kinds of market research and has been a programmer himself in Tens of programming languages. Earlier to the current position, Shubham has served for Motilal Oswal as Head of Quantitative, Technical & Derivatives Research and as a Technical Analyst at JM Financial.

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