Riskless Collar (Part 2)
Posted by Mark on July 3, 2018 at 07:04 | Last modified: January 5, 2018 09:30The saying is “no risk, no reward.” In the case of a guaranteed “MONSTER TRADE,” risk certainly abounds.
As another instance of potential pitfalls, consider the second example where I repurchase the stock at $150 after the first month and sell the 157.5 strike call for $300. Over the next 11 months, the stock falls back to the initial price of $100 thereby allowing all short calls to expire worthless. In this case, we have:
- -$1,200 to buy the initial long put
- -$10,000 to purchase the initial stock
- $300 for the initial short call
- $10,500 for the initial stock sale
- -$15,000 for the stock repurchase
- $3,300 for selling 11 monthly OTM calls
- $10,000 for the final stock sale
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The total after one year is -$2,100 (-13% on -$16,200).
We fall short of making any money at all in these scenarios, much less making 50% annually. Note also that:
- Transaction costs, which would lower returns, were left out of the consideration altogether.
- Call premiums were dramatically exaggerated (by 50-100%), which has artificially boosted still-negative returns.
- In the final scenario, I’m not even addressing the problematic implications of having to increase capital on the trade.
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The fatal flaw in this trade design is to assume I can simply continue to sell OTM calls and generate revenue.
If the market hits the short call strike then we need to consider action. A further rally will cause the long put to lose money while stock gains are offset. I may be able to roll the short call out and up for additional credit and for a greater potential stock gain. I could consider selling the put to recapture remaining premium and repurchasing if the stock falls back near the original price. None of this protects from a big price gap, though, where I wouldn’t be able to escape profitably at all.
I found a similar article (advertisement?) in my archives from Dec 2007. In the spirit of this blog mini-series, let’s delve in.
> Although I recommend simple, easy-to-execute trades in my
> ChangeWave Options Trader service, I personally use a variety
> of strategies to keep the profits coming and the losses limited.
I searched online for this newsletter/service. I was not surprised to see it no longer in existence.
> …it’s hard for me to wrap my head around the idea that a lot of
> people want to shy away from trading puts. After all, using put
> options to protect… stock… is like purchasing… life insurance…
>
> I’ve heard folks grouse that they “wasted…” money on a protective
> put because the stock didn’t go down. Huh?! It’s not like you buy
> a life insurance policy and say, “Damn! I didn’t die and get to
> cash it in!” You should just be glad that you had the protection
> in place and didn’t need it!
That’s a compelling argument—and funny too! Remember what I said about humor…