A zero-cost collar that is constructed with zero net premium. In other words, it is an equity collar often used by investors holding large positions in equity (shares of stock) in order to reduce their exposure to the unsystematic risk associated with the equity. The collar helps circumvent “constructive sales rules” that might be in effect if the investor did a short against the box or used an equity swap to alter the very nature of the return.

The collar would consist of a long put option with a strike below the current price of the stock and a short call option with a strike above the current price of the stock. The strikes would be set such that the premium received from the short call and the premium paid for the long put exactly cancel out.

Using a collar to place a cap and a floor on an equity position would provide a viable alternative to selling a portion of the position and investing the proceeds somewhere else (as this sale might result in a substantial capital gains tax, or in losing voting rights necessary to retain control, or in a negative signaling effect). Also, the investor might not be allowed to sell the stock because the stock is restricted or controlled.

For more, see: zero cost equity collar- an example.