We all know it costs money to buy options. But do you know there is a special options strategy that costs nothing?
We show you what is Zero-Cost Collar, and how to buy a Put for free to hedge against stock price crashes.
Contents
What Is Zero-Cost Collar?
The Zero-Cost Collar is a hedging strategy that combines a Covered Call with a long Put to create a zero-cost bearish options strategy. It can act as insurance against stock price crashes to limit the downside risks of our stock position.
How to Execute a Zero-Cost Collar?
A Covered Call is made up of a short OTM Call to generate income for a stock position:
- When the stock price increases, 100 shares will be sold at the Call strike price.
- When the stock price falls, we collect the premium from selling the Call option.
It's one of the most common options trading strategies.
Even though we collect the short Call premium when the stock price falls. If the bearish trend lasts for a long time, we can still lose a lot from our investment. So we can add a long Put to limit our downside losses.
The income from the short Call can offset the cost of the long Put, which means the Zero-Cost Collar becomes a free hedging strategy that adds a stop-loss for our shares.
It's free insurance against falling stock prices.
Why Use a Collar Option?
The Zero-Cost Collar has a few advantages:
- The long Put contract can set a stop-loss for the stock position.
- The premium from Covered Call and long Put cancel each other out to give us a free Put contract for hedging.
- The stock position can earn dividends.
- We can adjust the strike prices of Call and Put to suit different market expectations to reduce risks.
When we feel bearish about the stock price, we can trade a narrow Zero-Cost Collar to be more protective about the downside by setting a higher long Put price.
If we feel bullish, we can trade a wider Zero-Cost Collar with a higher short Call strike price to give the strategy more room to move upwards.
Risks of a Zero-Cost Collar
Here are some drawbacks of the Zero-Cost Collar:
- The short Call price limits the maximum profit for the strategy, as 100 shares will be sold when the stock price goes up beyond the strike price.
- The trade combines 100 shares with two option contracts, making it quite a complex strategy.
- It requires a lot of capital to purchase 100 shares.
Stock That Works Well With Zero-Cost Collar
The Bullish Value Stock picker uses Upside to sort a list of undervalued stocks that are ready to go up.
| Stocks | Description | Last | Fair value | Upside | Dividend yield |
|---|---|---|---|---|---|
| JD | JD.com Inc | $34.79 | $88.37 | 154.01% | 1.74% |
| VLKAF | Volkswagen AG | $164.01 | $359.09 | 118.94% | 18.76% |
| BIG | Big Lots Inc | $8.59 | $18.15 | 111.29% | 15.83% |
| LGFRY | Longfor Group Holdings Ltd | $24.92 | $52.37 | 110.15% | 6.21% |
| TCEHY | Tencent Holdings Ltd | $42.75 | $88.97 | 108.12% | 0.70% |
| ZLNDY | Zalando SE | $14.23 | $29.51 | 107.38% | |
| VFC | VF Corp | $18.79 | $38.29 | 103.78% | 6.27% |
| OCDDY | Ocado Group PLC | $13.35 | $25.44 | 90.56% | |
| PARA | Paramount Global | $15.74 | $29.62 | 88.18% | 1.23% |
| CTTAY | Continental AG | $7.39 | $13.70 | 85.39% | 2.08% |
JD is extremely undervalued right now with 154% of Upside. It is a great candidate for a Zero-Cost Collar to profit from a bullish outlook.
To trade a Zero-Cost Collar for JD, we must purchase 100 stocks first, then sell a Call that expires next month to offset the cost of a long Put.
So we get free downside protection to reduce the losses if the market crashes.
Now you know how to use Zero-Cost Collars to protect the stock value, we can use the value stock picker to find underlying to invest in long-term.
