Fun with Stock Collars
July 30th, 2008 by KenricI’ve been messing around with paper trading at Think or Swim for the past few months. I read an article about using Stock Collars with LEAPs and the ability to find trades that have 0% chance of losing money. It is really possible? I think it is when you use long term options. The pricing has to be right in order for this to work.
Here is a paper trade that I made last month (commissions not included).
I purchased 100 shares of Google at $550.76 for $55,076.
I Bought Jan 10 PUT 550 at $90.90 for $9,090 (gives me right to sell 100 shares of GOOG at 550)
I Sold Jan 10 Call 580 at $105.00 for $10,500 (gives someone right to buy my 100 shares of GOOG at 580)
I spent ($55,076 + $9,090 - $10,500) $53,666 on 100 shares of Google. This gives me a net purchase price of $536.66 a share.
What I really did here is that I paid $9,090 for the ability to sell the Google shares that I just bought at basically the same price I just paid. I can only lose $0.76 a share on my stock purchase. However, I paid $9,090 for this insurance. To offset the price of this insurance, I sold a Jan 10 580 Call which gives someone else the right to buy my shares of Google at $580. They paid me $10,500 for that right.
The $10,500 offsets the $9,090 and actually adds $1,410 into my pocket. This $1,420 lowers my Google share cost from $550.76 a share to $536.76.
So look at my trade now. I paid $536.76 for 100 shares of Google. I have the right to sell my shares at $550 up until January 2010. Someone else has the right to buy my shares at $580 up until January 2010.
I cannot lose money on this trade. Once January 2010 comes along I either sell at $550, $580 or somewhere in between.
Today
Today Google is at $477.12. The stock has dropped $73 a share from where I bought it.
How is my trade doing?
Google stock = $47,712 Net change -$7,364
Jan 10 550 PUT = $11,805 Net change +$2,715
Jan 10 580 CALL = $4,905 Net change +$5,595
I am up $946. However, with these collars its best to hang onto them until expiration. These trades are made to go almost all the way.
January 2010
What happens if Google goes below $550 on Jan 2010?
I exercise my Google 550 put and sell my shares at $550. The Jan 10 580 Call is worthless and expires. My profit is $55,000 - $53,676 = $1,344.
What happens if Google goes above $580 on Jan 2010?
The person who bought my Jan 10 580 Call exercises it and I sell them my shares at $580. My Jan 10 550 Put is worthless. My profit is $58,000 - $53,676 = $4,324. Note, this is also the maximum amount that I can make on this trade.
What happens if Google is inbetween $550 and $580 on Jan 2010?
The put and call are both worthless. I have 100 shares of Google at a price above $550 so my profit is at least $1,344 and less than $4,324.
Why don’t we all do it?
Wow, a trade where you can’t lose money. Why doesn’t everyone do this? Well because the return sucks. I am spending $53,676 for the chance to make between $1,344 and $4,324. That is a return of 2.5%-8.0% in a period of 18 months. You can get a safer return in a CD.
Of course, you can find certain put and call combinations that will increase your returns. You can use shorter term options to minimize your potential loss. Aren’t options fun?
Posted in Finances | 
Stumble it!
Well, options pricing theory basically comes down to the point that if you use options to eliminate the risk you receive the risk free return. And that is pretty much what you are showing here.
By moom on Jul 30, 2008
Before doing this for real, run the analysis again including commissions. They tend to eat into your profits quite a bit with options.
By Shaun on Jul 30, 2008
My paper trading account does include commissions. The trade is still profitable. I just didn’t want to confuse the math with commissions in the post.
By Kenric on Aug 1, 2008
A couple thoughts on your trade: To the upside, before commissions, you will make ~$3,000 on your investment of $53,666 (or about 5.5% over 2 years - or about half the APY of a decent CD.) With the stock and the sold CALL, you’ve created a covered call. What some might do is only buy the PUT when the stock has risen to near 580 to protect the stock’s gain. As the stock falls, most of the “loss” is offset by selling the PUT and realizing it’s gain. You can milk this numerous times until 2010 as the market fluctuates. It does carry risk though as the bottom could fall out before you re-buy your PUT.
Between real estate, poker, options, TOS, etc … we’ve got at least a few things in common. G/L with everything …
By Rob on Aug 5, 2008