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The Collar Strategy

May 31, 2016

Is it possible to trade binary options with minimal risk? The Collar strategy shows that this is possible. This strategy allows you to trade and minimize your risk.

The collar strategy is about buying an underlying asset and then simultaneously buying the Put option below the current price and selling the Call option above the current price.

If a trader manages to cover all the costs of his investment, in this case, it corresponds to the free collar. To illustrate this strategy, we will provide an example.

 

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A trader decides to buy 50 Apple shares, at the current price of $100 each in May. He also wants to buy protective call option at $102 in June, for $2. At the same time, he buys the protective put option at $98 in June for $1. Now, here is the total investment: $5000 for the shares + $50 for the put option, which is $5050. However, once he sells the call option (for $2), he gets back $100, so the total investment will be $4950.

On Expiry, the Apple shares rose 5 points upwards, to $105. Because the strike price of $102 for the call option is lower than the trading price of the stock, the call is automatically assigned and the trader would sell his stocks for $5100, which is a net profit of $150 ($5100 – $4950 original investment).

Well, let’s see what may happen if the Apple shares go downwards by 5 points to $95 instead? At $95, the call writer should have had incurred a paper loss of $500 for holding the 100 Apple shares but once the trader placed a protective put at $98 for July, he can sell now his shares for $4900 instead of $4750 (50*$95). In this way, the trader limited his loss paying only $50 of his pocket ($4900 – $4950 original investment).

In the case the Apple share price was maintained stable at $100 at the Expiry Time, the trader would anyway had a net paper gain of $600 as he only paid an amount of $4950 to acquire $5000 worth of stock.

Now it seems clear that when trading binary options using the collar strategy, we simultaneously buy and sell the binary option.

However, it is important to note that the use of a collar strategy is designed for investors who already have a good knowledge of financial markets. Therefore, we recommend the novice investors to be careful and choose the asset according to preferences, risks, potential, etc.

The great part of this strategy is that you can have peace of mind because you are protected. You cannot lose all of your investment. Even if the profit is limited, the risks are limited. With this strategy, you can place the orders and then just focus on your daily activities, or focus on other trading opportunities.

In conclusion, the collar strategy can be interesting to trade binary options if you already have good experience of trading in the financial markets.