Collar Adjustments

J

jones247

Although the synthetic equivalent of a collar is a bull call spread, I have a question concerning the adjustment of collars, as recommended by some "experts", such as Optionetics...

Many contend that the key to success when trading collars, is the ability to adjust the option positions when significant price movement in any direction occurs. In other words, if you entered a collar (having atm puts & calls), and the market subsequently drops by 10+%, then it would be best to roll the short call and the long put down toward the new atm strike prices. The idea is that if the market reverts (bounces) back, then you'll make a profit. However, if you failed to roll the options down after the market declined, then you would miss an opportunity to profit on the retracement.

Fundamentally, I don't understand the veracity of such a statement. Furthermore, I've yet to experience such results in any testing. The only benefit I observed with experiencing a decline of 10+% is that you now get to buy shares at a lower price as you increase the size of the collar. In doing so, you'll have a chance to profit with a smaller retracement. In effect, this principle of averaging down (scaling-in) appears to be the real benefit of experiencing a material drop in the price of the underlying stock (with the benefit of limiting your loss to a certain floor amount, not withstanding).

Please help me to understand what I'm missing with this notion of rolling down the short calls & long puts when a material drop in the stock price occurs, so that you can allegedly realize a profit (some contend a substantial profit) when/if the market retraces (bounces).

thanks,

Walt
 
Quote from jones247:

In other words, if you entered a collar (having atm puts & calls), and the market subsequently drops by 10+%, then it would be best to roll the short call and the long put down toward the new atm strike prices.
More...

1) If you have ATM Put/Call then isn't that a conversion?
2) Assuming not ATM, the natural equivalent is bull put spread - then all you're doing is taking a loss and entering into another bull put spread.

I'm not really seeing how this is much of an adjustment as much as closing and opening another trade. m2c.
 
Quote from jones247:

The idea is that if the market reverts (bounces) back, then you'll make a profit. However, if you failed to roll the options down after the market declined, then you would miss an opportunity to profit on the retracement.
More...

If you expect a retrace, there's better positions to take advantage. If you're more worried it won't retrace, then you probably shouldn't close out your first position to begin with (or maybe more accurately you should close it and leave it at that). I'm just not really seeing the benefit of the "adjustment".
 
If the puts and calls are ATM (same strike) then it's not a collar, it's a conversion and there's no point to adjusting.

I don't know if it''s the same article but some time ago I read an Optionetics article whose premise was that after a drop, you should roll the collar down and buy more shares with the proceeds at a lower price. That increases the size of your share position and you subsequently do more collars.

With eash drop/roll down, you incur losses (stock drop down to strike + or minus the cost of the collar). *IF* the underlying subsequently bounces, you recoup your losses and because you have a larger position, you profit on more shares. The more shares accumulated along the way, the larger the profit as compared with the original position.

The problem that I found was the range bound areas. Several consecutive debit collars were problematic. I'm not panning the concept because it works as long as the UL eventually gives you a free Get out of your collar (jail) card and you get assigned. If not, it's a slow grinding loser.
 
thanks for your replies guys...

I don't mean a conversion trade in establishing the collar, but instead a circumstance as follows: If a stock is trading at $50, then the long put would be at $47.50 and the short call would be at $52.50. Effectively, the classic collar scenario is what I meant.

Spindr0, my experience is as you've described. As I mentioned in my initially post, it seems that the "edge" with adjusting collars is really all about averaging down... unless I'm missing something.

Of course, as you mentioned, if the stock does not recover, then it becomes a strategy to ruin...
 
Edge may be debatale :)

But yes, I think that the gist of the strategy is averaging down when the UL drops below the protective put leg, increasing position size from its gains and profiting when the UL bounces. By any chance was AAPL the stock that was used as a example?

I have some historical data for a number of higher priced stocks (AAPL, BIDU, GOOG, PCLN, etc.). I made a cursory attempt to test this idea against it. Like everything, for some, it worked quite nicely. For others, not so hot. Nothing conclusive since I didn't look at enough set ups.

One thing that struck me at the time was that this is the kind of strategy that noobs should utilize because it has a non self destruct mechanism built in (protective put). You start with a collar and average up with your own money. Along the way you learn to adjust and get some trading experience. And with one good bounce, turn a bad pick into a profit. How viable it is for us know-it-alls is yet to be determined :)

All of this is highly unlikely because it's a more sophisticated approach that requires more knowledge. To paraphrase something apropos that STARDUST wrote earlier, the depth of knowledge and experience needed is enormous and many retail traders don't won't go there. So instead, they're encouraged to start their option experience with covered calls and we all know how well that works when it's a bear or you have lousy pick-ability.
 
I guess there's no "silver bullet" regarding rolling after a material drop in the UL price so that you can gain on the retracement...:confused:
 
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