Derivatives: How to create a ‘fence’ set-up Protects downside risk on the underlying by going long on put option Last week, we discussed a strategy called switch trade which involved going long on a futures contract and simultaneously shorting an out-the-money (OTM) call on the same underlying for the same maturity. This week, we discuss ‘fence’, another combination strategy. Limited downside A fence, also called collar or cylinder, involves going long on a stock and simultaneously shorting an OTM call and going long on an at-the-money (ATM)/OTM put on the same underlying for same maturity. The objective is to protect the downside risk on the underlying by going long on a put option. The cost of buying a put option can be subsidised through the premium collected on the short call. Sometimes, the premium collected on the short call will equal the put premium. In such case, the cost of setting up a fence (excluding the cost of the underlying) is zero.