Zero Cost Collar - A CEO Favourite

Continuing our analysis of using Exchange Traded Options in your trading we will outline a strategy used by many CEO's. - The Zero Cost Collar.

A zero cost collar is considered to be a moderate risk strategy.

To structure a zero cost collar when you are bullish about a stock you would buy a call and sell a put, however, if you are bearish you would sell a call and buy a put. The premium (income) received when selling (writing) one particular option offset the price of buying the other option, hence the name zero cost collar.

Example

If you were bullish about a stock you would buy a call and sell a put. Therefore, if you were bullish on Company XYZ with monthly option contracts on a certain date in mid-August when the price was $10.45, you would have bought a call and sold (written) a put.

The Pay-off diagrams for the components of the trade would look like this;

Buy $11 September call options for 48c

Sell a $10 September put option at 48c

Putting the two together would change the pay-off to this;

It is important to point out that if the share price of Company XYZ had stayed between $10 and $11, then this strategy has cost the trader nothing (excluding transaction costs). As the share price rose above $11.00 in line with the trader's bullish outlook, the trader is 'in-the-money'. If the share price had fallen below $10, the trader would be in a loss situation.