Zero Cost Collar: A Smart Hedging Strategy for Risk Management

Introduction

At Ultra, we guide investors through practical strategies to manage risks and optimise returns. One such advanced risk management tool is the Zero Cost Collar — a popular strategy among corporate treasurers, large investors, and traders dealing with currency or stock price fluctuations.

In this detailed guide, we cover:

• What is a zero cost collar?

• How does a zero cost collar work?

• Zero cost collar example

• Zero cost collar FX options

• Zero cost collar payoff

• How to use zero cost collar hedge in real scenarios

What is a Zero Cost Collar?

A Zero Cost Collar is an options strategy used to limit potential losses and cap potential gains simultaneously, without incurring a net upfront premium cost. It’s called “zero cost” because the cost of buying a protective option is offset by selling another option.

In simple terms:

• You buy a put option to protect against downside risk.

• You sell a call option to generate premium income.

• The premium earned from the call equals (or nearly equals) the cost of the put.

Thus, your hedge has no net upfront cost, hence the name Zero Cost Collar.

Zero Cost Collar Example

Let’s understand with a simple zero cost collar example.

Imagine you hold shares of Company X, currently trading at ₹500.

• You want to protect yourself if the price falls below ₹450.

• But you’re ready to cap your gains if the price rises above ₹550.

How does the zero cost collar hedge work here?

• Buy a put option with a strike price of ₹450 (pays off if stock falls).

• Sell a call option with a strike price of ₹550 (obliges you to sell if stock rises above ₹550).

The premium received from the call covers the cost of the put — creating a zero net cost hedge. You have effectively locked your minimum and maximum possible returns within ₹450–₹550.

Zero Cost Collar in FX Options

Zero cost collar FX options are very common among businesses with foreign currency exposures. For example, an exporter expecting USD payments may want to hedge against currency depreciation without paying large premiums for a put option.

So, they:

• Buy a put option to protect against USD weakening.

• Sell a call option with a higher strike to offset the cost.

This means the exporter has protection if the currency weakens beyond a level but gives up extra gains if the currency strengthens too much.

Zero Cost Collar Hedging Strategy

The zero cost collar hedging strategy is widely used because:

• It reduces volatility in returns.

• It provides a known range for minimum and maximum outcomes.

• There is no net upfront cost, making it cost-effective.

• It’s suitable for stocks, commodities, currencies, or any underlying asset with price volatility.

How Does Zero Cost Collar Payoff Work?

The zero cost collar payoff looks like this:

• If the price drops below the put strike, the loss is limited because the put option kicks in.

• If the price stays between the put and call strikes, the investor enjoys market movement.

• If the price exceeds the call strike, gains are capped because the investor must sell at the call’s strike price.

So, the investor trades unlimited upside for protection on the downside without paying a premium.

Benefits of Zero Cost Collar

• Cost-effective: The strategy neutralises the premium cost.

• Risk management: Provides a clear downside limit.

• Customisable: You can choose different strike prices to suit your view of the market.

Limitations to Know

• Capped gains: You limit your maximum upside potential.

• Margin requirements: Some brokers may ask for margin or collateral.

• Market knowledge needed: Picking strike prices requires experience and market view.

When Should You Use a Zero Cost Collar?

A zero cost collar hedge is best suited for:

• Investors holding large stock positions who want to lock in profits while limiting losses.

• Companies with large FX exposures wanting predictable cash flows.

• Commodity producers who want stable revenue despite price swings.

Ultra's Take: Is Zero Cost Collar for You?

At Ultra, we don’t offer direct zero cost collar trading, but we help our investors understand such strategies as part of their broader risk management knowledge. Whether you’re managing stock positions, currency risk, or exploring smart ways to hedge — it pays to know how a zero cost collar can protect your portfolio.

FAQs on Zero Cost Collar

1. What is a zero cost collar?

A zero cost collar is an options strategy where you buy a put and sell a call, so the premiums cancel each other, limiting both upside and downside.

2. Can you give a simple zero cost collar example?

If a stock trades at ₹500, you might buy a put at ₹450 and sell a call at ₹550. You’re protected below ₹450 but agree to sell above ₹550 — with no net cost.

3. How does a zero cost collar work in FX options?

Exporters or importers hedge currency exposure by buying a put or call and simultaneously selling another option to offset the premium cost.

4. What is the zero cost collar payoff?

Your losses are limited below the put strike, and gains are capped above the call strike, giving you a predictable range of outcomes.

5. Is zero cost collar a good strategy?

It’s a practical hedging tool for investors who want protection without paying upfront, but they must be comfortable giving up unlimited upside.

Final Thoughts

Understanding what is a zero cost collar, how it works, and when to use it can make you a more informed investor. Always align it with your goals and risk appetite.

Stay updated with more smart investing guides at Ultra — your digital partner for smarter opportunities.