Protective collars constitute an options strategy designed to simultaneously limit both the potential downside loss and the potential upside gain of an underlying asset. In crypto, this involves holding a digital asset, purchasing an out-of-the-money put option, and selling an out-of-the-money call option. It creates a bounded risk-reward profile.
Mechanism
The long put option provides a specific level of downside protection, preventing losses below its strike price. Concurrently, the short call option generates premium income, which can offset the cost of the put. However, this short call also caps potential profits above its strike price. The combination defines the maximum profit and loss over the option’s term.
Methodology
Investors utilize protective collars to reduce risk exposure in a volatile crypto asset without liquidating their position, particularly when anticipating moderate price movements. It offers a cost-effective method to hedge against significant adverse price events. This strategy allows for participation in some upward price action while providing a defined ceiling for capital preservation.
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