Financial Crisis Collar Strategy, Chasm (1)

Financial Crisis Collar Strategy

I was reviewing a list of potential topics for a BLOG when I was touched by one in particular: Financial Crisis Collar Strategy. That topic reminds me of a collar strategy that I managed in order to generate a capital gain with a stock when I sold it more than 50% below the purchase price. What? You are kidding, right? Well, you tell me.

  • On August 6, 2008 I bought Long Stock (LS) at $42.62.
  • I also bought January 40 Long Put (LP) at $3.94
  • Also, I entered a January 45 Short Call (SC) at $4.81

Those are the three instruments that construct a Collar Trade. The LP gives me the right-to-sell the equity at the 40 strike price ($40.00), while the SC brings on an obligation to sell the equity at $45.00, if it is in-the-money (ITM) at the time of expiration.

  • Net Cost Basis (CB) was $41.75
  • Risk of $1.75 (4.2%)
  • Primary Exit (PE) at $45.00 for a gain of $3.25 (7.78%)
  • Secondary Exit (SE) to manage the collar when evidence leads me to adjust the trade.

The 6-step methodology I learned as a member of OptionsANIMAL taught me to view the price chart at the end of each day. It always has a message for me.

Twenty-four hours after I entered this position the equity dropped more than 15%. I was very glad to have the Collar Trade secured. Over the next five months, I watched it daily and made some changes to the position. In September, I closed the SC by buying it back for $1.00, having captured the majority of the reward in a shorter period of time. Viewing a price bottom formation in September, I closed the LP for a nice profit, too. Within a few days, I saw the price bar meeting resistance at the 50 day moving average that prompted me to re-add another LP. I chose the at-the-money LP for January $35.00 and placed it back in the account. This gives me the right-to-sell the stock at $35.00. Over the subsequent months Short Calls brought income into my account (monthly basis) while the LP value inflated. The stock hit a low point at $12.31 on November 20, 2008. Somewhere above this stock price I closed my LP for more than 100% return on the investment and continued to open SCs against the LS. I allowed the stock to be called out of my account at January 2009 expiration at a price of $20.00. Imagine, even though I bought the stock for $42.62, I was able to manage the trade by using short-calls and long-puts and still take a profit in my account. (5.8% gain)

Since the Bear Market of 2008, we have not had a sustained market correction. Are we going to have another one soon? How can we protect our portfolio? Only with a firm knowledge of options behavior can we protect ourselves.

Earlier this year I noticed that Facebook, Inc. was extended from its base structure at just over $70.00 per share. I entered a long-term Put Calendar by selecting the January 2015 strike 70 LP and the March 2014 strike 70 SP. By rolling the SP, month-after-month at the strike 70, I was able to eliminate the entire debit on the January LP. In September, October and November, I selected the 75 SP. I am in a “free trade” with the January 70 LP. Will I end up taking the LS into my account at a price of $75.00? Because, if I do, I can either sell it in the open market or exercise my rights with my LP and still end up with a profit. Why didn’t I just structure a Collar Trade on Facebook? Hopefully, you can see that different markets offer different routes of success! All options behavior and spread-trade structuring are worth understanding.

Emilu Bailes
OptionsANIMAL Instructor

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