A Collar strategy involves holding a long position in the underlying asset while simultaneously buying a put option for downside protection and selling a call option to generate premium income. It is typically used to limit potential losses while capping potential gains.
Significance:
- Ideal for neutral to slightly bullish conditions, where an investor wants to protect against downside risk.
- Buying an OTM put provides downside protection, while selling an OTM call helps reduce the cost of the put.
- Profit is capped at the strike price of the sold call, while losses are limited due to the protective put.
Example:
- NIFTY trading at 18,000.
- Hold 1 lot of NIFTY Futures at 18,000.
- Buy 17,800 Put at ₹100 and sell 18,300 Call at ₹120 (lot size = 50).
- Outcome:
- If NIFTY stays between 17,800 and 18,300 at expiry:
- Both options expire worthless.
- Net profit = ₹20 × 50 = ₹1,000 (premium received).
- If NIFTY rises to 18,500 at expiry:
- Gain on futures = ₹25,000 (18,500 − 18,000).
- Loss on sold call = ₹10,000 (₹200 × 50).
- Net profit = ₹25,000 − ₹10,000 + ₹1,000 = ₹16,000 (capped).
- If NIFTY falls to 17,600 at expiry:
- Loss on futures = ₹20,000 (17,600 − 18,000).
- Gain from put = ₹10,000 (₹200 × 50).
- Net loss = ₹20,000 − ₹10,000 + ₹1,000 = ₹9,000 (limited).
- If NIFTY stays between 17,800 and 18,300 at expiry: