A defensive collar, within crypto institutional options trading, is a risk management strategy employed to protect an existing long position in an underlying digital asset from significant downside price movements while also capping its potential upside. It functions as a defined-risk structure, limiting both losses and gains to a predetermined range. This strategy is particularly relevant for investors seeking to hedge substantial crypto holdings against market volatility without fully liquidating their positions.
Mechanism
The strategy’s operational logic involves simultaneously buying an out-of-the-money put option and selling an out-of-the-money call option against an equivalent amount of the held underlying digital asset. The long put provides downside protection below a certain price, while the short call generates premium income to offset the cost of the put, but obligates the holder to sell the asset if its price exceeds the call’s strike. This creates a price “collar” around the asset’s current value, establishing a bounded risk-reward profile.
Methodology
Implementing a defensive collar requires careful selection of strike prices and expiration dates for the options, balancing the desired level of downside protection with the acceptable ceiling for potential gains. The methodology involves continuous monitoring of the underlying asset’s price, implied volatility, and the options’ time decay to determine if adjustments or early exits are warranted. This active management ensures the collar remains effective given changing market conditions and the investor’s risk tolerance, often executed through smart trading systems in an RFQ environment.
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