Variation of collar strategy

[sokoban]

Hi everybody,

First of all I apologize for the long post.

I have a stock that has appreciated and I want to protect against losses using a collar options strategy. I am uncomfortable however with the possibility that if the stock keeps going up, I may have to sell it if the call is in the money at expiration and gets exercised, which can trigger a hefty tax liability.

I thought of a way to avoid this drawback, but I want to make sure it will work as intended, and won’t raise any issues with the IRS.

Let’s say I own 100 shares of XYZ, the current price is 45 and the call strike price is 50. If the stock reaches 50 at any time during the life of the call, I buy another 100 shares of XYZ at 50 and I hold to it until call expiration.

If the call is in the money at or right before expiration, I have a couple of choices:
- I buy back the call right before expiration and instruct the broker to sell the 100 shares of XYZ purchased at 50, for a slightly negative overall net return, due to commissions and the low remaining time value.
- I wait until the call expires and when it gets exercised, I instruct my broker to sell the 100 shares I purchased at 50 (also for a slightly negative value due to commissions).

In both cases my overall gain/loss will be slightly negative, but I will be able to continue to hold the original 100 shares of XYZ.

This is a simplified case, as in reality the stock may keep moving up and down around the call strike price, in which case I would have to keep selling and buying the extra 100 shares.

I checked with my broker and they allow customers to specify which shares to sell (by entry transaction id) during the exit trade settlement period. As far as I know, this is also allowed by the IRS regulations (or the broker would not offer it to their customers).

Does this strategy make sense from a purely trading standpoint, and also from a tax standpoint?

Thanks!

 

[nazzdack]

Quote from sokoban:
----I have a stock that has appreciated....
----I am uncomfortable however with the possibility that if the stock keeps going up, I may have to sell it if....it....gets exercised, which can trigger a hefty tax liability.
----the current stock price is 45....
----call strike-price is 50.
---- If the stock reaches 50 at any time during the life of the call, I buy another 100 shares of XYZ at 50 and I hold to it until call expiration.

1) If you're concerned about a stock of yours that is a long-term holding potentially being called away, you shouldn't do any call-writing against your shares at all.
2) Instead of buying additional shares at the call strike-price, $50, you could offset the $50-call and short-sell another call-option farther out-of-the-money.
3) It would be easier to segregate your gains/losses on the option trades that way.
4) This would also serve to maintain your original strategy of having a collar around your shares with the upper-band being raised if the stock rallies.

 

[sokoban]

Thanks for your answer.

I have read about options and am familiar with the basic concepts, but I'm not experienced at actually trading options, so my ideas may be totally wrong.

1) If you're concerned about a stock of yours that is a long-term holding potentially being called away, you shouldn't do any call-writing against your shares at all.

1. The reason I want to write a call is to reduce the cost of buying the put.

I'll study your suggestion and may get back with additional questions.

Thanks!

sokoban

 

[MTE]

If you set up a collar and then buy extra 100 shares then you defy the purpose of the collar. That is, you have 100 shares, which you would like to protect so you set up a collar and then potentially buy another 100 shares. So you end up with 100 shares protected by the collar and 100 shares straight long with no protection.

So what happens when you hold those extra 100 shares and the stock gaps down!? In this case you'd be better off by just holding the original 100 shares with no protection at all.

If you are worried about assignment then, as nazzdack suggested, you should roll up the short call when it reaches the strike (i.e. you buy to close the original short call and sell to open another one with a higher strike).