Kenneth135_ Wilson

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What is a currency option collar and how do institutions use it?

A currency option collar is a strategy where a trader buys an out-of-the-money put option and sells an out-of-the-money call option on the same currency pair, thereby limiting both downside risk and upside potential. For example, a company with exposure to EUR/USD might buy a EUR put and sell a EUR call, creating a “collar” around its expected range. The advantage of using a collar is that it reduces the cost of hedging compared to outright options purchases, as the premium received from selling the call offsets the cost of the put. However, it also limits the potential upside if the currency moves favorably. Institutions use collars to hedge revenue flows or manage currency exposures within a defined risk range, particularly when they believe that significant price movements are unlikely. Retail traders may also use collars for cost-effective risk management, particularly when dealing with major currency pairs.