Continuing our analysis of using Exchange traded options in your trading we will outline a strategy used by many CEO's. - The zero cost collar.
A zero cost collar is considered to be a moderate risk strategy. To structure a zero cost collar when you are bullish about a stock you would buy a call and sell a put, however, if you are bearish you would sell a call and buy a put. The premium (income) received when selling (writing) one particular option offset the price of buying the other option, hence the name zero cost collar.
Previous Practical Example
If you were bullish about a stock you would buy a call and sell a put, therefore, if you were bullish on Zinifex (ZFX) on the 17/08/06 when the price was $10.45, you would have bought a call and sold (written) a put.
The Pay-off diagrams for the components of the trade would look like this;
Buy $11 September call options for 48c
Sell a $10 Septmember put option at 48c
Putting the two together would change the pay-off to this;
It is important to point out that if the share price of Zinifex had stayed between $10 and $11, then this strategy has cost you nothing (excluding transaction costs). As the share price rose above $11.00 in line with the traders bullish outlook, the trader is 'in-the-money'. In fact, the share price rose to the $12.00 level. However, if the share price had fallen below $10, the trader would be in a loss situation.