Bybit Learn

Options

With our collar option strategy guide, find out how you can effortlessly hedge your bullish long positions by selling a call and buying a protective put.

long-underlying-asset-payoff-diagram.png

covered-call-payoff-diagram.png

collar-strategy-payoff-diagram.png

option-collar-vs-protective-put.png

long-put-payoff-diagram.png

bybit-step-1.png

bybit-step-2.png

bybit-step-4.png

bybit-step-4-2.png

bybit-step-5.png

A collar option strategy is used to limit the returns of an underlying long position to a specific range. Typically investors use the option collar to hedge an underlying long position against downside volatility, and at the same time guarantee an exit if the market goes higher.

This is achieved by buying a protective put option and simultaneously selling a 

One way to think of the collar options strategy is it works the same way as placing both a stop-loss and a take-profit order against the underlying asset. By using the strategy, investors limit both the potential upside and potential downside associated with holding the underlying asset.

The first step in the collar option strategy is selecting which strike prices align with your market view.

Let's assume an investor holds 1.0 BTC, which is currently trading at $20,000 and wants to hedge against a drop below $18,000 in the next two months. They may do something like this:

Buy 1.0 BTC $18,000 put option with 60 days-to-expiration (DTE) — the buyer pays a premium of $1,000.

To offset the cost of the put, the investor then sells a covered call option. The call option is usually, although not always, for the same amount of underlying, and with the same expiration date.

The investor sells 1.0 BTC $22,000 call option with 60 DTE — receiving a premium of $1,000.

Here, the cost of the trade is zero ($1,000 premium paid -$1000 premium received). Depending on market conditions and the selected strikes, a collar option may be traded at zero cost (zero cost collar), a net credit (premium received > premium paid), or a net debit (premium received < premium paid).

The cost of the strategy varies depending on the distance of the strike prices to the underlying asset. Typically, a collar position involves strikes of equal distance to the underlying asset. Here, the premiums should hold equal, or close to equal value (delta-neutral).

Delta is the calculation used to determine how much an option premium changes in value for each $1.00 move in the underlying asset. Call options have a positive delta, ranging from 0 to 1, and puts have a negative delta ranging from -1 to 0.

At-the-money options typically have deltas of 0.5/-05, reflecting the equal odds of expiring either in or out-of-the-money.

Call delta increases as the market moves higher, and put delta increases as the price moves lower.

Understanding delta helps to explain the mechanics of the options collar.

If the underlying asset falls, the value of the long put increases at an ever-faster rate, helping to offset the loss in the underlying. If at expiration, the underlying asset is below the strike price, the put delta is -1.0, meaning the value of the put increases at the same rate the underlying falls. Here, the put perfectly hedges the difference between the strike price and the option settlement price.

By contrast, if the underlying moves higher towards the call option's strike price, the premium of the short call increases. Similarly, if at expiry, the underlying asset is above the strike price, the option delta is 1.0. Here, the losses incurred from the short put will offset the underlying’s gains 1:1 above the strike price.

The key difference is that for the short out-of-the-money call to expire in-the-money the underlying will be higher than when the trade was initiated.

The collar option strategy combines the protective put and the covered call strategy. As such, it can be used as an alternative to both.

Combining the two strategies has benefits and limitations. To understand the potential payout and risk of a particular options strategy, option traders use 

The below payoff diagram represents a long position in an underlying asset, like a stock or BTC. The black line is the price moving higher (left to right), and the blue line shows the profit and loss as the market moves away from the purchase price (A).

The main advantage of using the options collar as opposed to a covered call strategy, is the collar's protective put hedges against a drop in the underlying.

The below payoff diagram shows that when used in isolation, the covered call has limited potential profit, and a significant downside (premium received - the difference between the underlying asset price and $0).

 if the underlying price is above the strike price (calls), or below the strike price (puts). Here, there is an immediate benefit in exercising the options.

Any strike price in an unprofitable position relative to the underlying is referred to as Out-of-The-Money (OTM). For puts, this is a strike price below the current market price. For calls, it's any strike price above the current market price. Lastly, a strike price equal to the underlying asset price is called At-The-Money (ATM).

The long put, when used alone, protects against potential downside without limiting the potential profit— the maximum loss is limited to the purchase price of the option.

The collar is a simple option strategy with limited risk, and thus suitable for investors of all knowledge levels. However, to get the best from this play, it's advisable to select the strike prices that match your investment objectives.

As the name suggests, the reverse collar option involves doing the opposite of the traditional collar strategy.

The reverse collar is used to limit an underlying short position to a specific trading range. Instead of writing covered calls and buying puts, an investor with a short position sells covered puts and buys protective calls.

Here, the long call hedges the short position, and the short put limits the maximum profit potential.

The reverse collar is widely used in commodity markets, where its referred to as a "producer hedge". Commodity producers use the strategy to lock in both the best-case and worst-case price levels to exit their underlying short position (future production).

Because the covered call works against the underlying asset in a rising market, the collar option is best deployed when an investor is worried about near-term weakness.

The advantage of using a collar option as opposed to placing a stop and limit order against the underlying is its versatility.

With the collar strategy, the underlying asset could trade below the long put strike price whilst the contract is active but turns higher before the expiration date. Here, the protective put works perfectly, allowing the investor to weather near-term volatility but crucially keep their long-term long underlying position. 

Assuming the cost of entering the trade is zero (premium paid = premium received), the breakeven point at expiration is the same price as when the trade was entered.

Because the corresponding premiums offset each other, the underlying price determines the breakeven point. If the cost of the strategy is a net debit, the underlying asset must rise equal to that amount to offset the cost. Whereas for a net credit, the breakeven point is the price at which the underlying falls equal to the received credit.

The sweet spot for the collar option is when the underlying asset settles equal to the short call strike. Here, the short call is at-the-money and expires worthless and the investor keeps the gains generated from the underlying asset's price appreciation.

Because options are flexible, investors can adjust their position to reflect a changing view of the market. However, doing so can impact the max profit and loss potential.

Because the option collar offers downside protection, investors are unlikely to make adjustments in bearish markets. Instead, let's examine ways to adjust for bullish price action:

The maximum take profit potential is the same as the sweet spot. If the underlying asset is equal to the short call strike price at expiry, the call option expires worthless, and the investor profits from the underlying's appreciation.

The maximum incurred loss potential when using the collar strategy is if the underlying asset is below the long put strike price at the expiration date. Here, the maximum loss is the difference between the price of the underlying asset at the time of trade and the strike price of the put option (+/- the net cost of the trade).

The below example shows how an investor holding an underlying long stock position in Amazon (NYSE: AMZN) totaling 100 shares could use a collar option to protect against potential price volatility in the underlying security surrounding an approaching earnings call:

The investor purchases 1 contract (100 shares) of the Amazon $125.00 put option — paying a premium of $12.00 per share ($1,200)

The investor then sells 1 contract (100 shares) of the Amazon $145.00 call option with the same expiration month — receiving a premium of $11.50 ($1,150)

The cost of the trade is a net debit of $50.00 (premium received - premium paid x option multiplier of 100 shares).

Here, the investor's downside risk is protected if the underlying stock price falls below $125.00, with a guaranteed sale price of $145.00 if the short call option expires in-the-money.

With just a few simple steps, crypto traders can use Bybit's USDC-settled options to deploy the collar strategy to protect the underlying crypto holdings.

Log into your Bybit trading account and under 

Select the desired expiration date, or view all the available expiration dates at the same time.

Select the strike price you wish to trade. Call options are shown on the left-hand side of the option chain and puts on the right.

With the strike now selected, an order placement ticket appears. Here you will find the Greek calculations, the recent trades, and the market depth.

The margin requirement is calculated and displayed at the bottom of the order ticket once you have chosen your order size and direction (buy or sell).

Repeat the process for the remaining strike (either put or call) to complete the options collar strategy.

Accounts with minimum net equity of 1,000 USDC can take advantage of lower margin requirements and higher leverage by signing up for Portfolio Margin mode.

The portfolio margin mode uses a risk-based margin policy designed to reduce margin requirements for hedged portfolios. It does this by offsetting the exposure of long and short options positions against each other.

Because the underlying asset in the collar option hedges the option strikes, Portfolio Margin mode reduces the margin requirements for this strategy significantly.

Collar Option Strategy: Limiting Your Risk While Staying Bullish

Get your daily dose of crypto and trading info