What are the characteristics of this option strategy?
Costless collar positions combine a protective put with a covered call written against 100 shares the investor already owns. Because the call premium collected pays for the put, the hedge can be established for zero or close to zero net premium. This hedge permits the investor to protect themselves from downside risk below the put strike, while remaining exposed to upside profit potential up to the call strike.
The costless collar is considered an intermediate strategy for investors who have at least some experience with options trading. It is a limited risk, limited reward structure that places a cap on the maximum profits, while limiting the losses as well. The loss is only limited while the protective put is actually held. If the put is sold or allowed to expire and the shares are kept, the downside is open again.
Is this a bullish, bearish or neutral strategy?
The costless collar is a neutral strategy. It can be used to protect a long position in the underlying asset – either a single stock or an ETF – while maintaining exposure to potential upside gains.
Is this a beginner or an advanced option strategy?
The costless collar is best suited for intermediate to advanced options traders. It is important to understand the basics of options trading in order to successfully implement this strategy without taking on too much risk or missing out on potential profits.
In what situation will I use this strategy?
The costless collar can be used for a variety of different situations, but is especially useful for traders who hold a long position and are looking to limit downside risk while still maintaining upside potential. This is especially useful in volatile markets, where there is the potential for a large downside move. The trade off is that the short call caps the upside.
Where does this strategy typically fall in the range of risk-reward and probability of profit?
The risk-reward for the costless collar is limited. A trader's maximum potential profit is the call strike minus the price paid for the stock plus any net credit received, while the maximum potential loss is the price paid for the stock minus the put strike, less any net credit. Both of those outcomes are capped, so the collar trades away the tail on each side rather than raising the odds of a gain. The best case is the stock finishing at or above the call strike, and the worst case is it finishing at or below the put strike.
How is this strategy affected by the greeks?
The costless collar is affected by all of the commonly used option greeks. Delta is of particular importance, as the delta of both the protective put and the short covered call will affect the level of risk exposure. The gamma and vega will also have an impact, as these determine how quickly the hedge moves when market prices and volatility levels change.
In what volatility regime (i.e VIX level) would this strategy be optimal?
This strategy typically works best when volatility levels are relatively low. This is because when volatility is high, the extrinsic value (time value) of the options increases substantially. Put skew usually makes the downside protection the more expensive side, so it becomes harder to find a call whose premium fully pays for the put at a strike the investor is willing to sell at. The collar can still be put on, but the call has to be sold closer to the money, which tightens the cap on the upside.
How do I adjust this strategy when the trade goes against me? And how easy or difficult is this strategy to adjust?
Adjusting the costless collar when the trade is going against you can be quite challenging and it is important to understand how the different options affect the risk exposure and volatility. If the market begins to move in the opposite direction of the expected direction or the price of the underlying asset falls, it may be necessary to roll the original option positions to better align with the new market conditions.
Where does this strategy typically fall in the range of commissions and fees?
As with any options trading strategy, the cost of commissions and fees can add up quickly. The collar is a two leg options trade on top of an existing stock position, so expect two option commissions to open and two to close. Because the call premium offsets the put premium, those commissions are often the main out of pocket cost of the hedge.
Is this a good option income strategy?
The costless collar is primarily a hedging strategy, so it is not typically used as an income strategy. However, if the underlying asset remains relatively stable, then it is possible to receive a recurring credit by rolling the short call, while the purchased put continues to cost premium and cap the downside.
How do I know when to exit this strategy?
When deciding when to exit the costless collar strategy, it is important to consider the current market conditions and the outlook for the underlying asset. If the market is volatile and the outlook for the asset is uncertain, then it may be best to keep or roll the protective put and instead close the short call, so the downside stays hedged. On the other hand, if the market is stable and the outlook for the asset is positive, then it may be best to exit the strategy and close the short call so the shares are free to run again. Closing the call while keeping the shares also removes the premium that was paying for the put, so the put then has to be funded some other way.
How will market makers respond to this trade being opened?
Market makers will likely be neutral regarding the costless collar strategy. They are likely to view the strategy as a hedging tool and will not hold any particular bias.
What is an example (with calculations) of this strategy?
Here’s an example of a Costless Collar strategy using the stock MSFT whose current price is $285 by buying a protective put and selling a covered call against shares already owned:
Assuming that we own 100 shares of MSFT and we want to implement a Costless Collar strategy with the following options:
Buy 1 MSFT put option with a strike price of $275 for a premium of $3.50
Sell 1 MSFT call option with a strike price of $295 for a premium of $3.50
The put costs $350 ($3.50 x 100 shares) and the call brings in $350 ($3.50 x 100 shares), so the collar is established for zero net premium. The maximum potential loss is the $10 gap between the $285 stock price and the $275 put strike, or $1,000. The maximum potential profit is the $10 gap between the $285 stock price and the $295 call strike, also $1,000. Because the net premium is zero, breakeven stays at the $285 stock price.
If the stock price of MSFT falls below the strike price of the put option ($275), the put option provides protection against further downside risk. If the stock price of MSFT rises above the strike price of the call option ($295), we may be obligated to sell our shares at the strike price of the call option, which limits our potential upside.
How MarketXLS can Help
MarketXLS is an Excel add-in that helps investors analyze, research and model options. With MarketXLS, you’ll be able to model various options strategies, such as the costless collar strategy, with ease and accuracy. You’ll be able to analyze the potential risks and rewards of the strategy, making it easier to make informed decisions. MarketXLS also provides data on commissions and fees, making it easier to compare the costs of different strategies. In summary, MarketXLS provides a comprehensive and powerful suite of tools to make options trading easier and more profitable.
Here are some templates that you can use to create your own models
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