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Definition: Zero Cost Collar
It is a positive-carry collar having specific characteristics. In this case returns are secured by buying a cup and selling a floor. This is also known as “Equity Risk Reversal” or “Zero Cost Options”.
This is an investment strategy which is used in case of equities, options, commodities and interest rates. Investors who want to eliminate uncertainties in the return will buy a floor and sell a cap. On the other hand borrowers will follow the opposite strategy i.e. buy a cap and sell a floor. For investors, income generated from the floor will offset the cost incurred by the cap.
For example sale a call option and buy a put option with higher strike price. In case the price of underlying asset falls, the income from call will not only cap return but also offset the expense incurred to sell put. One of the disadvantages of this strategy is it has un limited upside risk.