Zero-cost collars

Discussion in 'Options' started by jimmyjazz, Mar 29, 2015.

  1. Could anyone point me to studies regarding the use of "zero" cost collars on a portfolio? I'm curious to see how they work in practice. I like the idea of not having to actively trade in and out of the underlying just to avoid major downturns, but the idea of capping monthly upside to (say) 5% in order to limit downside to (say) 10% makes me wonder how well such a collar might work in the real world.

    For what it's worth, I'm not so much worried about commission costs and fees as I am raw performance.
  2. rmorse

    rmorse Sponsor

    I don't have that study, but you pointed out the issue. Even if you find a zero cost collar, there is still a cost. You choose to go long that stock because you felt it would out perform the market. By adding the collar, you are limiting your upside, which is why you entered the position in the 1st place. Might I suggest that you simplify this. If your intent is to buy a stock you want to go long and use a collar to protect yourself, just buy a call vertical. Unless the stock pays a large dividend, your end result will be similar except with a lower cost of entry and less margin usage. The taxable return might change too.

    Any study would be dependent on how well you pick stocks. I have seen studies that show that buying a portfolio of stocks you like and use index options to hedge makes sense. I helps with market risk but does not take away to home runs.
  3. newwurldmn


    Zero cost collars are really for guys who have stock that they don't want to own but are forced to. For example, the owners of whatsapp might collar their Facebook stock to ensure they keep their billions. Same with mark cuban in the late nineties.
  4. traderob


    Just on a somewhat related question. Don't spreads also limit upside? So what distinguishes a spread from an iron collar in potential profits?
  5. rmorse

    rmorse Sponsor


    Buying a call spread=buying stock+put-call (if you use those same strikes as the call spread). Yes, they both limit losses and gains to the same extent. But, the call spread is simple and easier to enter and exit. The margin on the call spread is lower, so returns are higher. If the stock pays a dividend or there is any kind of corporate action, the math gets tricky.
  6. The collar might be something to consider for a good, large cap company with low volatility and good dividends like KO. You buy the underlying to capture the dividend. Then you buy the collar. Because of low volatility the options are cheap, so the cost of the collar will be minimal. You are not capping that much upside because the stock has a low chance of rallying.

    Most of the time, the options will expire worthless, but you are protected from a sudden market crash.
    There was a study I saw about using collars on QQQ,if you google 'Collar strategies', it is the one by the options industry council.
  7. This would be my angle. Pick a basket of stocks I like and then sell calls to finance puts on something like SPY to hedge downside risk.

    It appears that the margin costs aren't all that much better than the cost of the puts, though. A more complicated version (Cottle's "slingshot") also buys a further OTM call, and this can dramatically reduce margin costs.
  8. xandman


    You will probably find the book by Brian Johnson, Option Strategy Risk, interesting.
  9. Is that different than "Option Strategy Risk/Return Ratios"? I have that one.
  10. e.g.
    closed at 97.64
    Buy the stock, sell the June 97.50 call at 3.15 , buy the June 95 put at 2.96


    100............$5.00 + $85 dividend = $90

    The behavior of the underlying is the P/L determinant. Your reward/risk is 90/160 = .56

    I need the upside behavior on the underlying to be twice as likely as the downside in order to have an even expectancy (more or less). I also need the dividend for this to make any sense at all.

    Having a basket of these in an up market would be profitable and be hedged on the downside.... but you, of course, have given away the high upside for downside protection.

    Am I going to run out and put on this position??


    (you're not the first person to have this idea)
    Last edited: Mar 29, 2015
    #10     Mar 29, 2015