University Finance Report: Collar Strategy for Investment Hedging

This report provides a comprehensive analysis of the collar hedging strategy, a financial technique used to protect investments from potential losses. The report begins by defining hedging and explaining how options, specifically call and put options, are used in hedging strategies. It then delves into the specific application of the collar strategy, outlining how an investor can use a combination of put and call options to limit both potential losses and gains. The report includes calculations to determine suitable strike prices for the options, considering the investor's risk tolerance and desired return. It details the mechanics of the strategy, including buying put options and selling call options, and explains how to calculate the number of contracts needed. The effectiveness of the collar strategy is evaluated, demonstrating how it can successfully protect the portfolio's value while limiting potential upside. The report also includes a graph illustrating the strategy's payoff diagram and concludes with a list of relevant references. This report is designed to help students understand and apply the collar strategy in financial analysis and portfolio management.

Running head: COLLAR
Collar
Name of the Student:
Name of the University:
Author Note:

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Table of Contents
Hedging Strategy:.......................................................................................................................2
Hedging with Options:...............................................................................................................2
Hedging Strategy for the Question:............................................................................................3
Effectiveness of the strategy:.....................................................................................................4
Graph of the Strategy:................................................................................................................5
References:.................................................................................................................................6

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Hedging Strategy:
Hedging is the process to offset potential losses or gain from an opposite investment
which is taken by the investor. The hedging can be done by a number of ways such as
options, futures, swaps and many other financial instruments to safeguard a company or an
investor from potential losses or gains.
Hedging with Options:
The hedging with options can be done with the use of Call and Put options on an
investment and devising strategies to hedge the investment. The strategies which can be taken
for hedging depend on the investment belief of the hedger and certain strategies can be
implemented.
Certain strategies can be implemented when an investor has belief of volatility in the
underlying asset. In such a scenario the hedger can devise a long strategy such as straddle
where the investor purchases the put and call option at the same strike price and maturity.
The expectation of the investor is of volatility which would either profit the investor when the
underlying asset price falls or rises. The belief is of the underlying asset to experience
volatility, also a similar strategy can be used such as short straddle. Here the options are sold
and the volatility is expected to be low in the underlying asset.
Another strategy is the Bull/Bear Call/Put Spread where the investor takes a position
in either call or either put at different strike prices. The strategy is to take position in either
call or puts at different strike price and expect the volatility to remain low in the underlying
when the Bear Call Spread or the Bull Put Spread strategy is undertaken. The volatility is
expected to be high when the Bull Call Spread and the Bear Put Spread strategy is undertaken
by the investor.

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The above strategies elaborate certain strategies which can be taken by the investor
either to hedge the investments or profit from the strategies devised.
Hedging Strategy for the Question:
As the question highlights the investor wants to hedge the portfolio from the level of
$161000. Also the investor is willing to let go of returns which are 9% above the current
price of the asset. The current price of the investment is $173000, while the level after which
the investor is willing to let go of investments is calculated below,
Amount after which return is let go off = Current Price*(1+Required Return)
Amount after which return is let go off = $173000 * (1+ 9%) = $188570
The call option which would be suitable for hedging is with the strike of $1890. Since
the investor would earn 9% return till $1885.7, hence can forego the return which is greater
than this level. Thus the call option with $1890 strike is a suitable hedging option which
would be sold by the investor.
The put option which is favourable for the investor is $1610 strike since the investor
is willing to maintain a value of $161000 of the portfolio. The investor wants to hedge a fall
which is greater than $161000, so the put option at the strike of $1610 would be purchased by
the investor.
Also the reason to sell the call option is to reduce the cost of hedging, which the
investor is able to reduce by selling call option at $40 per contract and buying Put option of
$39 per contract. In this manner the portfolio is hedged from the downside when the investor
has let go of the upside.

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Also the investor wants to reduce the cost of hedging from the put options as the
constant hedging using put options is costly to the portfolio. Hence as per the expectations
and requirement of the investor the strategy which can be used for hedging the portfolio is
Collar.
This strategy involves the investor would purchase OTM put option at lower strike
price and sell OTM call option at higher strike price. Thus the investor would purchase put
contract at the strike price of $161000 and would sell the call option contract at $189000. In
this manner the cost of hedging is reimbursed by selling the call option contract. To
summarize the details of the hedging the following points are presented below,
 Buy put option contract at $39 per contract at the strike of $1610.
 Sell call option contract at $40 per contract at the strike of $1890.
 Current price of underlying is $1730.
The number of contract which would be required for hedging the portfolio of $173000
is provided below,
One contract = $(10* Strike Price)
Put Option Contract Required = Value to be hedged/$(10*1610) = 161000/16100 = 10
contracts.
Call Option Contract Required = Value to forego/$(10*1890) = 189000/18900 = 10 contracts.
The profit which can be generated from the collar strategy is provided by the formula below,
Profit=Call Strike−Underlying Price+ Net premium received
Profit=1890−1730+ 10∗(40−39)
Profit=$ 170

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Loss which can be generated from the collar strategy is provided by the formula below,
Loss=Underlying Price−Put Strike−Net Premium Received
Loss=1730−1610−10∗(40−39)
Loss=$ 110
Break Even Point for the collar strategy is = Underlying Price – Net Premium Received
= 1730-10 = 1720
Effectiveness of the strategy:
 The put option cost is $39, while call option is $40 hence the concern to reduce
hedging cost is reduced.
 If at expiration the price of underlying increases to $1910, call option is triggered and
the asset is sold for $1890. Hence the 9% upside potential is acquired by the strategy.
 If at expiration the price of underlying decreases to $1590, put option is triggered and
the asset is sold for $1610. Hence preserving the value of asset at $161000 is
achieved.
 Thus the hedging strategy of collar is successful.

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170
-110
1720
1890
1610
Collar Strategy Pay Off Diagram
Graph of the Strategy:

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References:
El-Hassan, N., Hall, A. and Tulunay, I., 2018. Methods and Performances of Collar
Strategies.
El-Hassan, N., Hall, A. and Tulunay, I., 2019. Methods and Analysis of Collar Strategies.
Israelov, R. and Klein, M., 2017. Practical Applications of Risk and Return of Equity Index
Collar Strategies. Practical Applications, 5(1), pp.1-5.
Isynuwardhana, D. and Surur, G.N.I., 2018. Return Analysis on Contract Option Using Long
Straddle Strategy and Short Straddle Strategy with Black Scholes. International Journal of
Academic Research in Accounting, Finance and Management Sciences, 8(4), pp.16-20.
Serafim, A.L.F., 2018. Performance of VIX straddle and strangle strategies in portfolio
management (Doctoral dissertation).
Zhao, H., 2020. An image segmentation approach on improved implicit surface model in
straddle strategy. Multimedia Tools and Applications, pp.1-13.