Zero-cost collars

[jimmyjazz]

I never claimed to have invented the idea. That said, I would probably be inclined to go farther OTM on the call and put.

And, I'm more interested in "collaring" a portfolio with index ETFs, not collaring the individual stocks. It's overall market risk I'm most worried about.

 

[oldnemesis]

lets look at the call spread:
buy the june 90 call and sell the june 95 call for a net debit of $375

(no dividends)


price...........Collar P/L........................................Spread P/L
100............$5.00 + $85 dividend = $90.......$125
97.64.........$90.00..............................................$125
97.35.........$69.60..............................................$125
97.00.........$41.23..............................................$125
96.00.........(58.87).............................................$125
95.00.........(160)...............................................$125
93.75.........(160)................................................0.00
90.00.........(160)..............................................($375)
85.00.........(160)..............................................($375)


The money is obviously in the spread.

 

[xandman]

Is that different than "Option Strategy Risk/Return Ratios"? I have that one.

Sounds like your already well versed in these strategies.

Anyway you really need to assume risk, any efforts to immunize market risk just lowers return. If you an indexer with a collar, might as well shop for a guaranteed annuity product that's tied to the market.

The opportunities are in selling puts because of the skew. However, I believe calls become over priced in a rising rate scenario.

 

[ogarbitrage]

The decision to enter into a fence is subject to many variables that are dynamic and need to be weighed at the time of execution. You should consider volatility, skew, upcoming earnings/dividends, recent appreciation/depreciation, purchase price, reason and time frame for hedging the position, etc.

For instance, if vol is bid on earnings but you're still bullish and want to maintain upside, then consider an aggressive put with a further OTM call but overall lowing your hedging cost. If you are neutral the share price with no expected announcements then consider 10-15% OTM zero-cost to allow peace of mind. If you're bearish then consider 0-5% OTM zero- or low-cost.

There's no black and white way to enter a fence. You can do zero-cost, low-cost, or collect a premium.

 

[oldnemesis]

How does all that compare to a June 85/90 bull put spread

No dividends


price...........Collar P/L.......................................Call Spread P/L......BP Spread
100............$5.00 + $85 dividend = $90.....$125.........................$73.00
97.64.........$90.00..............................................$125........................$73.00
97.35.........$69.60..............................................$125.........................$73.00
97.00.........$41.23..............................................$125.........................$73.00
96.00.........(58.87).............................................$125.........................$73.00
95.00.........(160)...............................................$125..........................$73.00
93.75.........(160)................................................0.00..........................$73.00
90.00.........(160)..............................................($375)........................$73.00
85.00.........(160)..............................................($375)........................($427)

 

[oldnemesis]

I never claimed to have invented the idea. That said, I would probably be inclined to go farther OTM on the call and put.

And, I'm more interested in "collaring" a portfolio with index ETFs, not collaring the individual stocks. It's overall market risk I'm most worried about.

There is no doubt that buying index puts will hedge you against market declines and financing them with index calls will not limit the 'outperformance' of individual stock selections...at least not as much.

I'll buy that.

The problem with such index hedging is that, unless your individual stocks are pure slaves to the index, the index hedging will not protect you against unexpected individual stock events which crash the individual stock.

To protect against index events I usually hedge via diversification. I.E. I have in my portfolio both long and short positions (e.g. bull call spreads, bull put spreads, bear put spreads and bear call spreads) on individual stocks each chosen according to expectations for the individual stock.

I find that when such a portfolio is faced with market declines it is highly resistant to those declines. The 'good' stocks are affected less by the decline and the 'bad' stocks exaggerate the decline. Thus in a market decline I often find my overall portfolio unaffected or even positively affected.

 

[jimmyjazz]

Understood, oldnemesis. Thanks for the input.

I'm curious -- what drives you to go bull call over bull put (debit VS credit), etc.? Is it just whichever prices out a bit better or is there a more fundamental market factor (vol, etc.)?

 

[OTM-Options]

Could anyone point me to studies regarding the use of "zero" cost collars on a portfolio? I'm curious to see how they work in practice. I like the idea of not having to actively trade in and out of the underlying just to avoid major downturns, but the idea of capping monthly upside to (say) 5% in order to limit downside to (say) 10% makes me wonder how well such a collar might work in the real world.

For what it's worth, I'm not so much worried about commission costs and fees as I am raw performance.

You like the idea of "not having to actively trade in and out of the underlying just to avoid major downturns"?

Show me a trader that actively trades in and out to avoid downturns (times the market) - and I will show you a trader that buys high sells low, churns his account, misses out on the rallies, under-performs the overall market, etc.

In simple terms ...... No trader can avoid the downturns, unless they give up something - like profit potential.

 

[jimmyjazz]

Well, I disagree. There are pretty simple long/short timing techniques on say SPY that can be shown to return ~ 12% annualized (before taxes, which tend to be on long term gains). It's not crazy good performance but it beats buy and hold. I assume one can get similar returns on individual stocks, although I admit I haven't really studied it.

But that's probably a discussion for the "Trading" forum.