Friday, August 21, 2015

Managing Collar Trades Before/At Expiration


From Our May 2015 E-mail Archives: One of our traders had a question about Collar trades before/at expiration, so he asked our Head Trader, Robb, for some guidance.*


-----Original Message-----

From: Evan S.
Subject: Collar Trade Management

Robb,

I just watched the "Retirement Planning – Session #3" class that you did on April 28, 2015. I had a quick question on trade management for the Collar trades; specifically, what needs to be done before/at expiration? The risk graph looks like a vertical spread, but as I'm thinking through it, the trade management will not be the same. In thinking through it, I believe that you should do the following if:
  1. Above Max Gain - Do nothing, short call will be exercised and you receive full premium, long put expires worthless and you will sell the stock

  2. Below Max Loss - Receive the full premium on the short call and it expires, long put will be exercised and stock will be sold

  3. Between Max Gain And Loss - Do nothing, receive full premium on short call and it expires, long put expires worthless and you keep the stock
Is this correct? Basically, you never have to do anything...it is just a matter of "Do you sell the stock or not?", right?

Thanks,

Evan S.


-----Reply Message-----

Hi Evan,

You have the right outcomes if you just let everything get exercised. However, there are actually some things that you can do to hold onto your underlying ETF/position. Here are the choices that you have on each:
  1. Above The Call That You Sold
    1. Do Nothing – You were correct about the outcome
    2. Buy Back The Call That You Sold – You may end up taking a loss on closing this short Call (if you are paying more to close the Call than you originally collected). However, you should have a nice profit overall. This is due to the stock having increased much more than the loss in the short Call position. By buying back the Call, you have removed the cap on the upside and are now back to a simple long stock position (with a profit). You would either let the long Put just expire worthless or close it out if there is any value left.
    3. Roll Up To A Higher Strike – Let’s say that you own an ETF and sell the $35 Call for $1.00 when the ETF is at $34. The ETF moves higher (unexpectedly, since you placed a Collar) towards $35.75 and looks to be breaking out. You could buy back the $35 Call for probably close to where you sold it and you could sell the $36 Call for $0.75 (or whatever the market price was). You have now given your underlying an extra $1 of profit. You would either let the long Put just expire worthless or close it out if there is any value left.

  2. Between Max Gain and Loss
    1. You are correct in your analysis and there really aren’t other choices.

  3. Below The Put That You Bought
    1. Do Nothing – You were correct on your analysis
    2. Sell The Put For A Profit And Hold The ETF – Obviously, this is the correct choice if the stock/ETF has reached a bottom and bounces higher from there. You will simply sell the Put for a nice gain, which offsets the loss on the ETF. I just did this in my retirement account two weeks ago on a long Direxion Daily Russia Bull 3X ETF (RUSL) position when it hit $36. I bought Protective Puts and closed out the Puts when the ETF pulled back to $31. I still hold the position.
Hope this helps,

Robb

* NOTE: Some original wording has been modified for legibility.
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