MikeL 2:43 pm on Wednesday, November 18, 2020

Calculating risk associated with a collar trade

A friend asked me a question about risk and collar trades. I provided an answer, but then started doubting if the answer was correct.

Example:

BTO 100 shares of XYZ stock
BTO 1 Jan 2020 $100 PUT
STO 1 Jan 2020 $100 CALL
The entire transaction was done for $100 debit.

I said that if the position is held until expiry, there would be not risk (not counting fees).

Is that correct or did I miss something?

smasty 4:06 pm on Wednesday, November 18, 2020

Hi Mike!
You need to look at the net debits/credits to assess risk, more like this:

Buy 100 Shares @ $100 = $10,000 debit
Buy qty 1 $100 put @ roughly $3.00 = $300 debit
Net investment: 10,300
Net risk, before selling a call, is (net investment) – (put strike) = $300
Now whatever you sell the call for is deducted from the $300….so if you can sell a $100 call for $3.00 yes, you are risk free, but you are also delta zero, so you have nothing but a zero profit/zero risk position. Profit requires risk. That’s why I place the put at 2% less than my breakeven after selling the call, and I make sure my short call premium is more than the put cost. That way I have positive delta, but minimal and defined risk.
p.s. I’ve found the single biggest key to successful collars is managing the put cost, since probably 75% of mine are throwaway.
- MikeL 5:01 pm on Wednesday, November 18, 2020
  
  Thank you Sue!
  - MikeL 5:19 pm on Wednesday, November 18, 2020
    
    After checking further I have learned that the purpose of this delta zero trade is to collect dividend without risking capital.
    
    If there is no risk to capital, then the only risk would be having the shares called away prior to the ex-div date (if calls go ITM), resulting is zero profit.
    
    Not sure how this would work in real life 🙂
smasty 6:50 am on Thursday, November 19, 2020

Might be interesting to model this for the upcoming COST special div