The Collar Strategy is a popular options-based hedging technique used to protect profits or limit downside risk while sacrificing some upside potential. It is constructed by owning the underlying asset, buying a protective put, and selling a covered call — forming a low-cost or even zero-cost position that caps both gains and losses within a defined range.

In forex trading, the collar strategy is particularly effective when a trader holds a long currency position and expects short-term uncertainty or potential reversal, but doesn’t want to close the position outright.

What Is a Collar Strategy?

A typical collar involves three components:

1. Long spot or futures position in the underlying asset (e.g. GBP/USD)
2. Buy a put option (for downside protection)
3. Sell a call option (to fund the put, capping upside)

All options have the same expiration, but the put strike is below the spot and the call strike is above the spot, defining a profit-loss corridor.

How the Strategy Works

1. Hold the Long Position
   Start with or continue to hold a long currency pair.
2. Buy a Put Option (Floor)
   Choose a strike below spot to limit downside losses.
3. Sell a Call Option (Ceiling)
   Choose a strike above spot to collect premium, offsetting the cost of the put.
4. Outcome at Expiry:
   • Price stays within strikes: Both options expire worthless; you retain the spot position
   • Price drops below put strike: Your downside is limited
   • Price rises above call strike: Gains are capped; you may be called away (cash-settled in FX)

Example: Collar on EUR/USD

• Long EUR/USD at 1.0900
• Buy 1-month 1.0750 put (floor)
• Sell 1-month 1.1050 call (ceiling)
• Net premium ≈ zero (depending on volatility skew)
• Outcomes:
  • EUR/USD > 1.1050 → max gain limited to 150 pips
  • EUR/USD < 1.0750 → losses capped at 150 pips
  • EUR/USD between 1.0750 and 1.1050 → you keep the spot exposure with no option impact

Ideal Market Conditions

• Uncertain Outlook: Protection needed without closing position
• After a Large Rally: Lock in gains and prepare for volatility
• Premium Balance Possible: Put and call can offset each other in cost
• Macro Events Ahead: CPI, NFP, or central bank risk

Benefits of the Collar Strategy

• Downside Protection: Limits major losses on the long position
• Cost-Effective Hedge: Often created with little or no net premium
• Disciplined Profit Targeting: Prevents emotional overtrading on gains
• Defined Risk and Reward: Ideal for structured portfolio management

Risks and Limitations

• Capped Upside: Limits profit above the call strike
• Still Bears Spot Exposure: Small losses possible within the collar range
• Complexity in Execution: Must coordinate three legs accurately
• Early Exercise Risk (for equity options): Less relevant in FX, which are often cash-settled

Risk Management Tips

• Choose Strikes Strategically: Balance how much downside you’re willing to accept with how much upside you’re willing to cap
• Use Into Events: Place collars ahead of high-volatility announcements
• Monitor IV Skew: Helps optimise net cost — higher call IV helps fund cheaper puts
• Exit Early If View Changes: Close collar or leg out if bias shifts dramatically

Use Case: USD/JPY Collar Before BoJ

• Trader long USD/JPY at 150.00
• Concerned about volatility around BoJ decision
• Buys 149.00 put, sells 151.00 call
• Cost ≈ breakeven
• Outcome:
  • Gains capped at 151.00
  • Losses limited below 149.00
  • Remain in position while managing risk on both sides

Conclusion

The Collar Strategy is a versatile and prudent way to manage risk while still maintaining upside exposure within a controlled range. It is ideal for FX traders and investors who want to protect profits, hedge macro risk, or structure trades for stability without completely exiting positions.

To master collar constructions, options-based risk strategies, and portfolio protection techniques in live forex markets, enrol in our Trading Courses designed for disciplined, hedging-focused, and options-driven traders.