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How to Utilize the ThreeWay Collar Hedge

Written by admin
Mon Jan 16 2023
How to Utilize the ThreeWay Collar Hedge - MarketXLS
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How to Utilize the ThreeWay Collar Hedge - MarketXLS

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Effective Utilization of the Three-Way Collar Hedge Strategy

The Three-Way Collar Hedge is an effective strategy for controlling volatility and mitigating risk for option traders. The Three-Way Collar Hedge employs the usage of three options at the same time and together, a qualified covered call, a protective put option, and a long stock position. This strategy allows traders to see a gain from their investments and to buffer against potential losses. Here are some tips for utilizing the Three-Way Collar Hedge strategy as effectively as possible.

Protective Put Option

The Protective Put option acts as an additional form of insurance against losses and can help to mitigate risk by protecting share value in the event of a market downturn. The protective put option works by securing any losses at a certain pre-determined price. The investor buys ‘put’ options with a strike price lower than the current market value of the stock and, if the stock drops, the investor can exercise their put option to sell the stock and receive their predetermined price.

Qualified Covered Call

The Qualified Covered Call is the second component of the Three-Way Collar Hedge. This is essentially a type of ‘covered call’ where the investor buys the same amount of calls as they have shares in the same underlying security and holds them until they expire. This allows traders to generate income from their share position in a market that has little to no volatility. This strategy works as a hedge and can continue to generate income in both neutral and bearish markets.

Long Stock Position

The third and final component of the Three-Way Collar Hedge strategy is the Long Stock Position. This requires the investor to purchase a set amount of the underlying security, usually near the current market price, and then hold it until the options expire. This position allows the investor to benefit from any potential bull markets, or increase in share value, and benefit from the premium income from their qualified covered call option.

Risk Management & Portfolio Diversification

By utilizing the three-way collar hedge, investors can effectively manage volatility and reduce potential losses. This strategy also allows for some measure of portfolio diversification by helping to offset potential losses from other positions. This way, investors can benefit from a more balanced portfolio by setting up a ‘risk-neutral’ position.

Put-Call Parity and Profit Neutral Positions

Another benefit of using the Three-Way Collar Hedge is the ability to create ‘Profit Neutral’ positions by taking advantage of Put-Call Parity. Put-Call parity is the relationship between the prices of a put and call option and their underlying asset. By taking advantage of this concept, investors can employ a variety of strategies to help create a more balanced portfolio while still maintaining their overall risk level.

MarketXLS – HelpingMake Trading Easier

At MarketXLS, our goal is to make trading easier for investors. We provide a suite of customized tools to help investors make the best decisions for their portfolios. Our option analytics platform is designed to help traders create and manage their Three-Way Collar Hedge positions easily and effectively. We help you to make trading faster, simpler, and more profitable.

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