Contents:It often happens that financial markets enter into an unpredictable phase, traders and investors become nervous, the volatility jumps and the price action is getting wild. At first glance, such trading conditions might seem perfect for speculators as volatility is the best friend of profit. On the other hand, any market turmoil is usually coming together with a much higher level of losses due to rapidly changing sentiment. Besides focusing on higher profitability of the trading algorithm, binary options traders should keep in mind the money management rules and a healthy profit-loss ratio.
Therefore, sometimes it is essential to arrange a set of trading rules aimed to minimize potential losses, while any trading strategy has to be flexible in terms of reacting on intraday shifts of the market’s focus. Traders might consider opening so-called collars or locks when a call option opened for one underlying asset is followed by a put option for the same security. However, given the structure of the binary options type of trading such a method might lead to a fixed loss. Traders developed a Costless Collar - a trading method designed to avoid losses wherever the price goes.
What is Zero Cost Collar?
A zero cost collar is a technique suggesting two multidirectional deals on the same underlying asset with different entry prices and expiration times.
Thanks to simple calculations based on variable payouts in binary options, traders can provide attractive strike prices and trading volumes in order to get the collar with zero cost. These steps create a Costless Collar Binary options.
Collars are particularly popular with Company Executives with large portfolios of stock held in trust (ie they can only access it after several years).
How does a Zero Cost Collar work?
The primary purpose of the zero cost collar was for trading options for stocks. However, the development in the technology of trading allowed adapting the trading method for binary options as well. This approach requires manual control of trading deals and it would not be suitable for automated trading systems. One of the main advantages is that when a previously opened deal is not doing well in terms of profitability, and the trader is not sure about the overall outcome at the end of the expiration period, it’s worth opening a collar with the fixed zero-loss, and shift to other assets to trade on. Although such a lock requires a certain amount allocated for the collar, the rest of the trading account is free to open new deals. Therefore, the flexibility remains at a high level with the condition to keep the money management rules and not to open deals for too high trading volume at one time.
Another application of the zero-cost collar is possible in a very short period right before the previous option expires. For instance, having a put-option for gold with a 4-hours expiration time, a trader can set an alarm to monitor the price action 30 minutes before the end of the deal. If the current price of gold went too far in the negative territory (gains strength) and there is almost no chance for the rate to come back in the profitable zone, the trader can open several 5-minutes call-option deals or one 15-minutes position with the appropriate trading volume to get the collar in the non-loss mode. On the other hand, if the previous deal is currently in the money right before the expiration deadline, there is no reason to make any changes in the trading strategy.
There are different approaches to get a zero cost collar in terms of the expiration time. Some traders prefer analysing the market and opening deals based on the same timeframe, others use different charts to monitor. In the first case, a protective option is opened with the same expiry as the initial one. The second choice is related to opening a second deal with a shorter expiration time. For instance, if a 24-hours put-option deal was opened at the beginning of the day, but the price action becomes wild and the price of the underlying asset goes far from the entry-level, then a 4- or 1-hour call-option position could be opened for the same financial instrument. Thus, the initial deal can be saved from the negative territory.
How to calculation Zero Cost Collar?
Since the payout system is different from one asset class to another, traders can also vary the trading volume in order to get out of the fixed loss. Increasing the trading volume for the second protective position could help traders to compensate for the previous loss from the initial deal if the market goes in the wrong direction.
The formula is quite simple as it is based on a single variable - the payout.
If, for example, the payout for the underlying asset is equal to 80% and the trading volume for the first deal was $100, then the protective deal’s trading volume should be calculated as $100/0.80=$125.
Example of profitable using
The British Pound was gaining strength versus the U.S. dollar on October 3, and the technical analysis pointed to a possible breakout of the round-figure resistance level of 1.2400. A trader was buying 4-hours call options and two of them were in the money, according to the the 4-hourly chart below.
However, the price action showed that the resistance is too strong and the demand for PUT options is robust near the resistance. The 15-minutes chart below shows the price action during the 4-hours period. A simple analysis based on Japanese candlestick patterns suggested that the previous call option is in danger of getting into the negative territory. Therefore, the trader bought a put option with 15-minutes expiry. As a result, wherever price went, the outcome would have been pat and with zero losses in the worst-case scenario.
If you like this strategy, you might also be interested in this Rainbow Strategy
The Zero Cost Collar is a trading technique based on a protective trading strategy aimed to compensate possible losses from previously opened deals in case if the market conditions changed during the expiration time. This trading technique requires manual control for the trading positions with a possible intervention by the trader in case if needed. The main approach is to control risks related to an uncertain outcome and thus avoid possible losses. In some cases, the costless collar method might lead to profits, even though they would be less than in a best-case scenario. Nevertheless, the method might be considered as a part of the hedging strategy in the binary options. It is not suitable for automated trading systems.