There are many ways to trade appreciating collars (I'll forget about protective collars for the time). Some observations on the appreciating collar (assumption is long stock plus long atm put plus short otm call, same expiry). 1. as already pointed out by others, the original collar is risk free if initial short call covers cost of long atm put (ignoring dividend issues for time being). 2. when stock moves up, one makes money by rolling up the put provided the cost of rolling is less than the difference in strike prices (i.e. original put strike minus rolled up put strike). 3. if stock goes nowhere, one loses money from evaporation of extrinsic value of long put. 4. if stock goes down, and position was opened for some debit (i.e. short call premium did not cover put cost) then that debit will be lost. One way to try to avoid/minimise this loss is to buy back the short call (should be cheap after significant bearish move) and sell a new, still otm strike, call. At the same time the put will need to be rolled down to the new atm or close to the money. There will be some extra money left over from the put roll, this can be used to purchase more stock and further puts to cover the new stock - the new position will have a higher net delta and thus further benefit from a bullish move. 5. selling the calls is optional and depends on one's view. 6. rolling only works when there has been a significant price movement, say greater than 5% in the underlying. 7. failure to roll down after a significant downmove will limit losses but will also result in a slower "recovery" of the position's profits. As one can notice, this is really a dynamic hedging collar strategy, iow adjustments are a necessary part of this for optimal profits and many variants are possible, e.g. ratioing the put strikes. Naturally, one wants high volatility for the sale of the call to be worthwhile if using near month calls and longer term puts. Best daddy's boy
Ok, I've had a look at it. The above trade has a guaranteed profit of $6 for each collar, provided it is held til jan 07. Unfortunately the cost of holding this til jan 07 may be more than the $6 (I think the brokerage is more than that). The good news - the potential max profit is $256 if the stock is at or above $7.20 at expiry. So, it's a "risk free" trade except for the cost of carry and brokerage. Best daddy's boy
Forget the credit. The maximum the $2.50 vertical can make is $2.50 - debit paid to own the vertical. In this instance, the vertical is put on for $0.06 credit. Therefore the maximum the position can make is $2.56 and the minimum is $0.06 at expiration.
Let's ignore synthetics, theta, time value and vega for the moment and keep it simple. Look at the long stock + long put by themselves: WLP @$77.44 Buy Jan 07 72.5 PUT for $2.9 If WLP drops to $70, have you or have you not lost money on the position (again ignoring time value etc.)? Yes, the loss is limited or capped but you have still lost unfortunate as it is. Now, bringing the CALL back into the equation: Sell Jan 07 75 CALL for $7.9 Again, if WLP drops to $70 and you decide to buy back the sold CALLS for less than what you sold them for as you suggested. Here's the question, will the profit on the CALLs be greater, less than or similar to the loss I hope we agree happens on the long stock + long PUT position? Your hypothesis is that the profit on the CALLs will be greater than the loss on the stock/PUT position if WLP drops and therefore you are able to lock in a profit. I'm suggesting this will not be the case under most circumstances. Why? Because the long stock + long put position, as stated has unlimited upside and capped downside i.e. it is identical to a long CALL with a 72.5 strike. The downside is capped to the debit paid for the CALL. This long CALL at 72.5 being further in the money (larger deltas) than your short CALL at 75 will lose more when the stock goes down than the short CALL will gain. Far out from expiration the difference can be negligible. On the plus side, if WLP happens to rally, then there are ways of locking in further profits (at the risk of reducing probabilities for max gain on the vertical) by selling the appropriate butterfly to roll the vertical up or buying a vertical to reduce the width of the vertical etc. Why am I saying it is possible to lock in profits on a rally but not on a sell off? Because, your initial position is bullish/neutral it makes money in flat to up conditions. It therefore loses money in down conditions. Lastly, if you do decide to pursue the buying back the sold CALLs route and selling further down, you have to be careful where you write those subsequent CALLs If you write the CALLs at the same strike as your owned PUTs then you are effectively boxing/offsetting your original bullish vertical. This means, whatever the locked in profit/loss of the trade at this point, no matter where the underyling finishes at expiration, the PnL will be the same. If you however, write the CALLs at a lower strike than your owned PUTs then you are in fact turning the bull vertical into a bear vertical. Which means you now want the underlying to finish lower to make maximum on the vertical. I apologize if I have been too verbose. MoMoney.
Alas, downside protection does not equal no loss. The downside protection max loss is the debit paid for the synthetic CALL (long stock + long PUT).
>If WLP drops to $70, have you or have you not lost money on the position (again ignoring time value etc.)?< Yes, I now understand what you mean by it losing money. Hmmm, not sure where all this leaves me. Might have to stay here and think all day...hehe boots
useful formula: collar trade risk=stock price-put strike+net premium paid "Look at the long stock + long put by themselves: WLP @$77.44 Buy Jan 07 72.5 PUT for $2.9 If WLP drops to $70, have you or have you not lost money on the position (again ignoring time value etc.)?" In momoney's example the "married put" risk=77.44-72.50+2.9=7.84 Then, when you sell the call (to convert the married put to a collar) for 7.90 your risk becomes a guaranteed minimum profit of 0.06. Hope this helps clarify a rather complex strategy. daddy's boy
momoney wrote: "This long CALL at 72.5 being further in the money (larger deltas) than your short CALL at 75 will lose more when the stock goes down than the short CALL will gain. Far out from expiration the difference can be negligible." That's why the put needs to be rolled down. daddy's boy
Agree. On your dynamic hedging collar strategy (thanks for the notes) this is feasible. However, when both PUT and CALL have the same tenor as per boots example, rolling down both the PUT and the CALL is buying a butterfly i.e. you are locking in a loss in order to improve the probabilities on vertical at expiration. That is, unless you leg it over a period of time and the underyling moves favorably in the interim. The minimum $0.06 expiration credit on the collar at inception will be replaced by a minimum $debit equal to the cost of the butterfly - $0.06. MoMoney.
What if you just roll down the Put and leave the Call alone? (The more I learn the more I don't understand how I have been doing so well....dumb luck I guess) boots