Synthetic Collars refer to a risk management strategy in cryptocurrency options trading where a portfolio’s downside risk is limited and upside potential is capped, using a combination of long and short options contracts and the underlying digital asset. This strategy replicates the payoff of a traditional collar using derivative instruments when direct options are unavailable or illiquid. Its purpose is to define a specific risk-reward profile for a digital asset holding.
Mechanism
The operational mechanism involves holding the underlying cryptocurrency, selling an out-of-the-money call option, and buying an out-of-the-money put option. The short call generates premium and limits upside, while the long put costs premium and provides downside protection. When a direct collar cannot be constructed, a synthetic collar utilizes other options equivalencies, such as a long put combined with a short future, to achieve the same risk profile.
Methodology
The strategic application of Synthetic Collars allows institutional investors to manage exposure to highly volatile digital assets by systematically bounding potential losses and gains. This methodology provides a cost-effective way to hedge large spot positions, particularly in markets where liquidity for specific options strikes may be thin. It is a critical tool for structured product creation and risk control in advanced crypto portfolio construction.
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