In my mind the reverse collar is more expensive because most brokers do not pay interest on the short proceeds from the stock. However, you are "paying interest" because carrying cost is built into the price of the long call. Hence a net negative compared to regular collars where the interest you lose buying the stock is offset by the carrying cost component of the short call. Basically, the carrying cost loss of the RC loses you almost 5%. Okay, it might be cheaper in the sense that the cash outlay is less for the reverse collar. On possible answer is to short single stock futures instead of the equity. SSF's pricing has a carrying cost component that then works in your favor when shorting. Don
Not exactly correct. You won't long the call and short the put at the same strike in a reverse collar, and so it is not a synthetic long position.
What do you mean by cheaper, and why will a reverse collar produces a higher return? Can you illustrate it with an example?
I am definitely interested in seeing your adjustments, on both sides. 1) I was a bit disappointed to find that my broker (and I think all of them do this) keep the cash from shorting separate from my regular money market cash, thus I don''t earn any interest on it. 2) I believe this is an IRS restriction. 3) Shorts actually have to pay the dividend. The long stock holder that you borrowed from gets a Payment In Lieu (PIL), which is taxed as ordinary income.
Hi gang. I'll respond to Eliot's points, when he said: I am definitely interested in seeing your adjustments, on both sides. 1) I was a bit disappointed to find that my broker (and I think all of them do this) keep the cash from shorting separate from my regular money market cash, thus I don''t earn any interest on it. 2) I believe this is an IRS restriction. 3) Shorts actually have to pay the dividend. The long stock holder that you borrowed from gets a Payment In Lieu (PIL), which is taxed as ordinary income. =================== 1) Eliot, you're correct that the broker generally does not pay you interest on the proceeds from the short sale which are deposited into your account. However, if the proceeds are left in your account, those proceeds are included in your Adjusted Cash Balance, hence you are not charged margin interest expense. I have no problem with this because the way I look at it, if I have no capital outlay, there is no need for me to collect any interest income. 2) I believe you are correct that this is an IRS restriction. But, what difference does it make whether it is an IRS rule or a brokerage rule? If you can't do this in an IRA, you can't do it. 3) Regarding the fact that one who shorts stock has to pay the dividend, this is absolutely correct. This is what I was referring to in item (3) in my posting above where I discuss the ex-dividend issue. Thanks everyone for all the comments. Hope we get a lot more. 4Q
Hi YIP. What I meant when I said that the percentage return on investment is higher in a Reverse Collar than a Regular Collar is that the denominator for computing the percentage is significantly lower. In a Reverse, I regard the denominator as the Maximum Risk. I recognize that this conclusion is subject to endless debate. In a regular collar the denominator includes the cost of the stock, the cost of the Put, less the proceeds from the Short Calls. I've seen some write ups on collars where the annualized yield is no better than if the person had taken the same money and had purchased Treasuries. 4Q
Don, respectfully I disagree that the cost of a Reverse is not lower than the Regular Collar. Regarding the fact that interest is not paid to me on the short sale proceeds of the stock, I cover this on Page 3 here in my response to Eliot. Regarding the fact that interest is included in the price of the long call...well I agree that the Rho factor is always included in the price of any option. Just as you are correct regarding interest being built into the price of the long call, if one were to do a Regular Collar, that interest would be reflected in the price of the long Put. So, with respect to the use of the Regular or Reverse, the issue discussed in this paragraph is interchangeable.
Although you have no capital outlay the cost of your long call has a "cost to carry" component so you are in effect paying interest. Because you do not earn interest on your short proceeds to offset this cost you are in effect losing about 5%. Contrast this with a normal collar where the cost to carry component of your short call works in your favor. That is, it offsets the loss of interest that your cash outlay to buy the stock would otherwise earn. So a reverse collar has about a 5% disadvantage to the normal collar. Don
Don, in a reverse, the proceeds from the short put accomplishes the same thing as the short call in the Regular. 4Q
True, but a Call is more expensive than a Put because it contains the cost of carry. So when you have a short call it offsets the cost of carrying the stock. However, when you have a long call you are paying the cost of carry, but there is no offset. Therefore a reverse collar incurs a penalty of the cost of carry which today is about 5% annualized. However, as you rightly point out less capital is need for a reverse collar which of course is an advantage. And because less capital is needed the resulting smaller denominator for the P/L calculation increases your leverage. So this small denominator indeed magnifies profit, but it also magnifies losses. For example, if the denominator is say 50% smaller for the reverse collar the 5% cost of carry loss becomes 10%. In summary, you really have to analyze the prices of both collars to determine the best P/L opportunity. Don P.S. As I mentioned earlier because single stock futures contains a cost of carry component shorting the futures instead of the stock overcomes the above cost of carry penalty of the reverse collar.