8 Ball, you requested that I expand upon (1) in my posting this morning at which time I stated:
"(1) I don't always have shorted puts, because their only purpose is to help defray the expense of the long calls."
The first two parts of a Regular Collar are (a) long the stock and (b) long the Puts. These two legs, are called married Puts. In the case of a Reverse, it is just the opposite. The first two legs are (a) short the stock and (b) long the call. Together these are referred to as a married call.
The married Call is a very good strategy. Assume a stock is selling at exactly $85. Let's assume further that we do the following trade:
(1) Short 1,000 shares of UNDerlying at $85 and receive $85,000 in shorted proceeds.
(2) Buy 10 April $85C @$10, for a total cost of $10,000.
Total net credit (exclusive of commissions) is $84,000.
For simplicity, let's assume that the delta of the Calls is 50, or +500 deltas for the 10 calls. The shorted shares have a negative delta of 1,000, so the net is a negative delta of 500. Thus, at this point we have a bearish trade. For reasons which I'll go into in greater depth in subsequent postings, I really don't care which way the stock moves, as long as it moves $5 in any direction during the month.
At this point, let's just concentrate on the maximum risk, which is $10,000, the extrinsic value of the Calls at the time of purchase. But, this potential risk of $10,000 maximizes only if t he stock is exactly at $85 and only at April expiration.
So, here's the answer to your question in terms of shorting the Puts. As I said in the quote, the only purpose of the Put is to collect premium in order to profit from theta decay. That theta decay profit accomplishes nothing but reduce the $10,000 risk referred to in the preceding paragraph.
I'll stop here for now.
4Q
"(1) I don't always have shorted puts, because their only purpose is to help defray the expense of the long calls."
The first two parts of a Regular Collar are (a) long the stock and (b) long the Puts. These two legs, are called married Puts. In the case of a Reverse, it is just the opposite. The first two legs are (a) short the stock and (b) long the call. Together these are referred to as a married call.
The married Call is a very good strategy. Assume a stock is selling at exactly $85. Let's assume further that we do the following trade:
(1) Short 1,000 shares of UNDerlying at $85 and receive $85,000 in shorted proceeds.
(2) Buy 10 April $85C @$10, for a total cost of $10,000.
Total net credit (exclusive of commissions) is $84,000.
For simplicity, let's assume that the delta of the Calls is 50, or +500 deltas for the 10 calls. The shorted shares have a negative delta of 1,000, so the net is a negative delta of 500. Thus, at this point we have a bearish trade. For reasons which I'll go into in greater depth in subsequent postings, I really don't care which way the stock moves, as long as it moves $5 in any direction during the month.
At this point, let's just concentrate on the maximum risk, which is $10,000, the extrinsic value of the Calls at the time of purchase. But, this potential risk of $10,000 maximizes only if t he stock is exactly at $85 and only at April expiration.
So, here's the answer to your question in terms of shorting the Puts. As I said in the quote, the only purpose of the Put is to collect premium in order to profit from theta decay. That theta decay profit accomplishes nothing but reduce the $10,000 risk referred to in the preceding paragraph.
I'll stop here for now.
4Q
.