In the active world of finance, investors are constantly seeking innovative strategies to optimise returns while managing risk. One such intriguing approach is the “Zero Collar Strategy”, a method that not only provides downside protection but also enables investors to leverage their concentrated bets.
Understanding the Zero Collar Strategy
The Zero Collar Strategy involves combining two options: purchasing a protective put option and selling a covered call option. This combination creates a collar-like structure around an existing asset, providing a floor and a cap for potential gains and losses.
- Purchasing a Protective Put: A protective put option acts as an insurance policy for your portfolio. By buying a put option, you gain the right (but not the obligation) to sell your asset at a predetermined price, known as the strike price, within a specified timeframe. This protects your investment from significant downside risk.
- Selling a Covered Call: Simultaneously, you sell a covered call option against your asset. This involves agreeing to sell your asset at a predetermined price (higher than the current market price) within a specified timeframe. In return, you receive a premium, providing some income and creating a cap on potential gains.
Know: Introduction to Call and Put Options
Leveraging Concentrated Bets
Example Scenario:
- Initial Investment: You have a concentrated bet on Stock XYZ, currently valued at Rs. 10,00,000.
- Selling a Covered Call: You decide to sell a covered call option against your asset. You sell one-call contract with a strike price of Rs. 11,00,000. Let’s assume you receive a premium of Rs. 10,000 for selling this call option.
- Purchasing a Protective Put: Simultaneously, you purchase a protective put option with a strike price of Rs. 950,000. The cost of this put is the premium you pay to acquire it. Let’s assume the cost of the put is Rs. 20,000.Now, let’s calculate the net cost or benefit of the options strategy:
- Premium Received from Selling Covered Call: Rs. 10,000
- Cost of Purchasing Protective Put: Rs. 20,000
Net Premium Received or Paid: Rs. 10,000 (Premium Received) – Rs. 20,000 (Cost of Put) = -Rs. 10,000.
- Calculating Collateral Value: The collateral value, against which you can borrow, is the market value of Stock XYZ minus the net cost of the put. In this example, it would be Rs. 10,00,000 – Rs. 10,000 (net cost of the put) = Rs. 9,90,000.
- Borrowing Against Collateral: Many financial institutions allow investors to borrow against the collateral of a well-structured portfolio. In this case, you can borrow a percentage of the collateral value, say 50%, providing you with additional funds for other investments or personal use. This would amount to Rs. 4,95,000.
- Financial Flexibility and Risk Mitigation: By borrowing against the collateral, you unlock financial flexibility without needing to sell your concentrated position. This borrowed capital can be used for various purposes, such as diversifying your portfolio, seizing new investment opportunities, or meeting personal financial needs.
Conclusion
The Zero Collar Strategy, coupled with borrowing against the collateral, offers investors a unique blend of risk management and financial flexibility. By implementing a protective put and a covered call, you create a structured approach to safeguarding your portfolio while capping potential gains. Leveraging this strategy by borrowing against the collateral allows you to access additional capital without liquidating your concentrated bets.
However, it’s essential to note that options trading involves risks, and borrowing against collateral introduces an additional layer of complexity. Investors should thoroughly understand the mechanics, risks, and costs associated with these strategies and consider consulting with a financial advisor before implementation.
