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The strategy allows the investor to costless hedge while maintaining potential for profit in the position.

TWO weeks ago, we saw how some investors can use collars to get a limited upside with a limited downside using combination positions. To recap, an equity collar involves a long position in the cash market, a long put and a short call.

The strike price of the long put and the short call is to be decided by the investor depending on the protection required. The long put puts a floor below which, if the stock falls, the investor is protected. The short call acts as the cap above which, if the stock rises, the investor does not benefit.

Investors commonly use two types of collars: zero-cost collars and income-producing collars.

Zero-cost collar: This is a good strategy for a bullish investor who believes that the underlying stock will continue to rise in value. These collars involve the purchase of a put and sale of a call, with the strike price of the call set to generate exactly enough cash to pay for the put. The strategy allows the investor to costless hedge while still maintaining potential for profit in the position.

Income-producing collar: This represents a more conservative approach.

* It involves the purchase of a put and sale of a call with the call strike price set relatively close to the current price of the underlying stock.

* This lower strike price of the call will lead to a cash inflow to the investor. But this will be higher than that required to pay for the purchase of put option.

* This strategy "sacrifices" some potential profit as compared with the zero-cost collar.

* These are also `collars for credit' because investors who prefer to have immediate cash in their hands would prefer to use this strategy.

Collars for debits: An alternate strategy would be to go for `collars for debits'.

* In this, the call option written will be out of money that is much higher than the current market price.

* The investor will end up paying cash to buy the put option.

* Aggressive investors use this strategy, as they want to have more profits, if the stock rises, and hence pays accordingly.

Benefits: The important benefits of a zero cost collar (ZCC) are

# It provides for taking position with no initial outlay.

# It helps investors holding stock to protect against adverse price movement while capping the upward movement

# It helps investor to receive all corporate benefits like dividends etc. from their position in the stock but with the relevant protection.

Suitability: ZCC will suit the following types of investors

# Shareholders, whose holdings have appreciated in value significantly, but wish to protect their holdings around the current price levels.

# Investors who hold most of their assets in securities but would like to release some cash from their holdings without actually selling them and also protect against downside movement can go for collars for credits.

# Employees with vested stock options who want to protect the downside or when they want to fund part of their acquisition.

When a ZCC is used as a method of share protection, the investor can set the floor level and the cap can be calculated leading to a zero outlay. The higher the floor, the lower will be the cap required to achieve zero outlay. Conversely, if a lower floor is set, a relatively higher cap can be achieved.

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