Collar is a hedging instrument for customers that find the cap premium too expensive and are willing to have a floor (minimum level) in the falling markets. You purchase a cap and finance all or most of it (zero cost collar) by selling a floor, depending on the cap and floor levels. There can be an upfront premium. The strategy can be adjusted to suit your needs, and there is a cash settlement every month.

Rewards

• Protection against rising markets
• Low or zero cost
• Flexibility in physical supply

Risks

• Some opportunity cost if the market falls
• Basis risk in some cases
• Premium to be paid in some cases

 
Collar example
In December you decided to buy a collar, running from January to March at a quantity of 2,000mt per month. We agree on a maximum price at $525/mt and a minimum price at $518/mt.

The average settlement price for January was $515. You pay OW Bunker $3 x 2,000 = $6,000.

For February the average settlement price was $521. No settlement, because the price is within the cap and floor.

For March the settlement was $530. OW Bunker pays you $5 x 2,000 = $10,000.

Your total profit is $4,000.





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