A volatility collar is a multi-leg options strategy designed to protect a portfolio from adverse price movements while simultaneously limiting upside gains, effectively capping both potential losses and profits. Its purpose is to reduce risk exposure in a volatile asset, such as a cryptocurrency, by establishing a defined range of potential outcomes for the underlying holding.
Mechanism
This strategy is constructed by holding a long position in an underlying asset, purchasing an out-of-the-money put option to set a price floor, and simultaneously selling an out-of-the-money call option to finance the put purchase and cap upside participation. The premium received from selling the call partially or fully offsets the cost of buying the put, making it a cost-efficient hedging instrument.
Methodology
The strategic application of a volatility collar allows investors to hedge against significant price drops in a crypto asset while sacrificing some potential upward movement beyond the call strike. This methodology is often employed when an investor holds a strong conviction in the asset long-term but seeks to mitigate short-term downside risk without liquidating the position, providing a structured approach to risk management in unpredictable markets.
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