An option on an interest rate collar. It gives its holder the right, without the obligation, to trade a collar at or by a specific expiration date. In other words, a collartion allows the holder to buy or sell an interest rate collar at an agreed-upon strike rate on (if the collartion is European-style) or before (if the collartion is American-style) a given date against a specified premium.
An investor purchasing a collartion would gain in case the floating interest rate on the underlying instrument (a note) climbs above or drops below a specific level. Otherwise, that investor can simply choose to refrain from exercising the collartion. As the collartion goes unexercised, the investor loses the premium, but at the same time, he is said to have hedged interest rate risk and volatility risk in both directions.
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