Collar Advance: A Simpler Approach to Variable Prepaid Forward Contracts

Learn how you can unlock liquidity at lower rates while reducing risk on your large stock positions

Srikanth Narayan
Founder and CEO

What is a Collar Advance?

A Collar Advance is a financial contract that lets large stockholders unlock liquidity today while deferring the sale (and taxes on gains) to the future. It uses a collar strategy, discussed in more detail below, to reduce downside risk (and preserve upside potential), often making an underwriting bank more comfortable lending against the stock. This also means investors can access cash at typically lower rates than standard margin loans on stock.

There are two parts to the transaction: the collar and the cash advance.

The Collar

A collar is a well-known hedging strategy to limit downside risk on a stock investment. Typically, investors buy a protective put option that protects them on the downside at a floor price. To offset this cost, a call option is sold on the same stock, which limits the upside participation.

For example, your stock is trading at $100 and you are looking to borrow against it. You choose 80% downside protection, and put options are purchased at $80.

Cap: The “cap” is the maximum upside participation you have in your stock's growth during the contract's term. The cap limits your potential profits in exchange for downside protection.

Floor: The "floor" is the price level below which you are shielded from further loss in value.

Term: A collar advance is a fixed-term instrument.

The Advance

Once the collar is set, the underwriting bank can lend you $80 since the collar offsets any loss in stock value below $80 for the next two years. Assuming the collar is costless, the bank will advance you the $80, less the prepaid interest over the term.

You can use the Collar Advance proceeds for any purpose, including:

• Bridge financing for a purchase and sale of real estate
• Investing in a diversified portfolio
• Funding a long/short strategy to generate tax losses
• Starting a company
• Exercising stock options
• Paying a tax liability

It’s also important to note that the structure of the Collar Advance transaction gives you liquidity without triggering a taxable event upfront.

How does a Collar Advance work?

Example Step-by-Step

1. Indicate your interest
   You or your advisor will contact a provider to express your interest in a Collar Advance.

2. Review proposals with different terms
   You review proposals with different term lengths, levels of floor protection, and advance amounts.

3. Execute the transaction
   Once the agreement is signed, you’ll open an account and transfer your shares to the underwriting bank.

4. Receive your advance in one lump sum payment
   As soon as everything is set up, you’ll receive liquidity via a single payment.

What happens at maturity of the Collar Advance?

At the end of the term, there are three possible outcomes based on where the share price stands relative to the cap and floor:

• Between the cap and the floor: You settle the loan with stock or cash.
• Above the cap: You owe stock to cover the loan at the cap price.
• Below the floor: You deliver all pledged stocks or pay back the amount in cash.

Benefits of a Collar Advance

• Typically lower borrowing rates
• Downside protection with floor
• Tax deferral
• Retain ownership rights
• No margin calls or forced sales
• Flexibility in usage of funds

Risks and other considerations

• Opportunity cost of capped gains
• Loss up to floor price
• Early exit considerations
• Dividend tax rate impact
• Complex structure
• Significant minimums
• Repayment risk
• Tax risk

How much liquidity can you raise with a Collar Advance?

The amount of liquidity that can be generated through a Collar Advance depends on:

1. Floor Price
2. Cap Price
3. Interest Rates

Comparing a Collar Advance to some alternatives

Margin loans

• Advantage: Quick liquidity
• Disadvantage: Margin calls and forced liquidation.

Securities-Backed Lines of Credit (SBLOCs)

• Advantage: Flexible use of funds
• Disadvantage: Risk of maintenance calls.

Who are Collar Advances for?

Collar advances are for investors with a long-term outlook who hold a concentrated position in a single stock. Important factors include:

1. Concentrated Stock Position Size
2. Expected Term of Ownership
3. Market Outlook
4. Major Capital Needs
5. Tax Considerations
6. Risk Tolerance

Getting started with a Collar Advance

At Cache, we bring them to more investors while making it easy and transparent. If you’d like to learn more, look at what we offer, or tell us about yourself and the stock you’d like to borrow against.