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.
![atvi covered call](https://slashtraders.com/wp-content/uploads/2023/07/atvi-covered-call.png)
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.
![atvi long put](https://slashtraders.com/wp-content/uploads/2023/07/atvi-long-put.png)
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.
![atvi zero-cost collar](https://slashtraders.com/wp-content/uploads/2023/07/atvi-zero-cost-collar.png)
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 ATVI stock price, we can trade a narrow Zero-Cost Collar to be more protective about the downside by setting a higher long Put price.
![narrow vs wide collar](https://slashtraders.com/wp-content/uploads/2023/07/narrow-vs-wide-collar.png)
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.
![blog trial banner](https://slashtraders.com/wp-content/uploads/2021/05/blog-trial-banner.png)
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.
The JD Zero-Cost Collar is made up of 100 shares, a short Call that expires next month to offset the cost of a long Put.
![jd zero cost collar](https://slashtraders.com/wp-content/uploads/2023/07/jd-zero-cost-collar.png)
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.