Collar is a perfect option trading strategy for turbulent times

Shubham Agarwal

We are all aware of the shocks that certain global events can bring into our markets. Such are the times when traders get choosy out of caution. There are always many attractive bargain hunting opportunities. However, while being cautious, we might just miss out on a winning trade by just skipping it.

Well, there is a strategy involving Futures and Options that can help us contain the risk and take care of the caution. This can basically mean we can trade any opportunity regardless of how risky the market conditions are. The strategy I am referring to is Collar.

Collar is one of the most conservative strategies. It is best suited for bargain hunting in market conditions that are changing every day based on some developments that are uncertain.

Let us see how to create a Collar strategy along with its benefits.

Construction of a Collar:

Buy a Future

Buy a Put Option (Strike can be just below the current market price)

Sell a Call Option (Strike can be close to short-term upside target)

Logic behind this trade is making a Protective + Cost-Effective trading strategy.

Protection: By buying a Put option along with Future will make sure that we do not have to be worried about having that big gap down.

Even if we are not able to catch the fall, we can be assured of the fact that losses on Future will be compensated by profits on Put.

Cost-Effective: Since buying Put option will require us to pay premium, with Collar we have a way to fund this payment. At all times we work with an upside target where we are okay booking profit. So, instead of keeping that level in mind, let us just Sell a Call option of that strike.

Buy Future + Selling Call = We are ready to forget any profits above that Strike price.

Selling Call means receiving premium. This action will help us reduce our cost of acquiring Put option. This makes it cost-effective.

There are a few characteristics of Collar that one must know about.

Since this strategy has maximum risk that is limited and known, the margin requirement will definitely be much lower than Buying a Future.

At the same time the only limitation is that with a lower amount of risk we get a lower amount of profit potential. So, if we have a runaway rally, our profits will be limited to the Call strike we sold.

Also, this strategy is typically aimed at taking trade that will run through the remainder of the expiry. There is a possibility that the move up to our Sold strike (Upside Target) comes along in just two to three sessions.

In such a case there will be trading profits, but it may be less than 50% of that of profits if we had only bought Future. However, the way I see it is even the margin requirement is lower in Collar, so to a certain extent it evens things out.

Finally, if we are afraid and do not trade, there is opportunity lost. On the other hand, if we do trade without realising the danger there is a risk of a big loss. So, that is why perfect strategy for turbulent times is Collar.

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