A Zero Cost Collar strategy is the same as the Collar Strategy, except that the investor bears no cost to enter into the trade.
The investor buys the underlying security and simultaneously sells an out of the money call and buys an at the money put of the same underlying and same expiry.
The premium of both, the call option of higher strike price (OTM) as well and the put option of lower strike price (ATM), should be the equal.
The name ‘Zero Cost’ comes from the fact that there is little or no cost to enter the options strategy as the premium paid for buying the put option is offset by the premium received for selling the call option.
How to Build the Strategy:
This strategy has three legs:
Leg 1 – Buy the underlying security, quantity being equivalent to the lot size of the option contract
Leg 2 – Sell 1 OTM Call
Leg 3 – Buy 1 ATM Put
Note – The strike price of the call option depends upon the volatility of the underlying security. The more volatile the underlying, the further should be the strike price of the call option.
Credit Spread/Debit Spread
As the name itself suggests, this a no cost option strategy since the premiums of both, call and put, are the same.
This strategy has limited profit potential.
When is this strategy profitable?
Max profit is attained when the underlying security price reaches the strike price of the call option sold.
The investor faces little to no risk in this strategy as there is no cost for buying the put option.