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Collar Trades: The Rationale for Maximum Gains and Losses

Covered call writing trades have 2 legs: the long stock position and the short call. The collar trade adds a third leg, the long protective put. The calculations for potential trade maximum gain or loss can be confusing. This article will break down the mathematics and provide a rationalization for these computations.

 

The 3 legs of the collar trade

  • Buy a stock in 100 share increments (long stock position, a debit)
  • Sell out-of-the-money (OTM) calls agreeing to sell our shares at a price higher than current market value (a credit and placing a ceiling on the trade)
  • Buy OTM protective puts allowing us the sell our shares at a known lower price (a debit and placing a floor on the trade)
  • The collar trade is structured such that the short call credit and long put debit results in a net option credit (the premium generated from selling the call > the cost of the long put)

 

Maximum gain

This occurs when the price of the stock moves to or higher than the short call OTM strike. The maximum gain is realized when the profit earned from share appreciation of the stock moves from purchase price up to the OTM call strike. We then add in the net option credit to get the total dollar maximum return. The percentage return is calculated by dividing by the cost of the stock.

$ Max gain = (Call strike – Stock purchase price) + net option credit

% Max gain = $ Max gain/Purchase price of shares

 

Maximum loss

This occurs when the price of the stock moves to or lower than the long put OTM strike. The maximum loss is realized when stock value moves from purchase price down to or lower than the OTM put strike. We then add in the net option credit to get the total dollar maximum loss. The percentage return is calculated by dividing by the cost of the stock.

$ Max loss = (Put strike – Stock purchase price) + net option credit

% Max loss = $ Max loss/Purchase price of shares

 

Hypothetical example with the BCI Collar Calculator

 

Collar Calculations Using the BCI Collar Calculator

In the screenshot above, if BCI is purchased at $83.32 and the call strike is $84.00 (option credit of $3.16) while the put strike is $77.50 (option debit of $1.26), the calculations are as follows:

Max gain:

  • Stock gain ($84.00 – $83.32) = $0.68
  • Option net credit: ($3.16 – $1.26) = $1.90
  • Net position ($0.68 + $1.90) = $2.58
  • On a cost- of $83.32 = 3.10%

 

Max loss:

  • Stock loss ($77.50 – 83.32) = -$5.82
  • Option net credit: $1.90
  • Net position: (-$5.82 + $1.90) = -$3.92
  • On a cost- of $83.32 = -4.70%

 

Discussion

When calculating maximum gain or loss for our collar trades, we must have 3 data points:

  • Net share gain or loss
  • Net option credit
  • Cost of shares

The initial trade structuring must result in a net option credit. The BCI Collar Calculator will do all the mathematical legwork for us.

 

For more information of the collar strategy

Best book

Best online video course with downloadable workbook

Best calculator

 

Your generous testimonials

Over the years, the BCI community has been incredibly gracious by sending our BCI team email testimonials sharing stories as to what our educational content has meant to their families. Moving forward, we have decided to share some of these testimonials in our blog articles. We will never use a name unless given permission:

Hi Alan,

I’ve been a BCI member for about 3 months.  I was already comfortable with the technical and fundamental side of stocks. For me learning options was a different animal, I couldn’t grasp the concept easily. I tried studying a few other online teachers and was ready to give up when someone suggested your site. I spend 15-20 hours a week reading your books and online streaming. You have a lot of material to learn from which is great, but a person has to put in the time to study. The end of Feb. or beginning of March, I will be ready to make my first option trades. I’m very excited but wish markets were better. So, thanks to your style of clarity and teaching, options make a lot of sense to me now.  Keep teaching so we can keep learning.

Stan

 

Upcoming events

1.Mad Hedge Summit: Free Zoom presentation

Tuesday March 15th at 11 AM ET

Selling Cash-Secured Puts: 4 Practical Applications 

Selling cash-secured puts is a low-risk strategy which generates weekly or monthly cash-flow. This presentation will detail how to craft the strategy to multiple applications which will align with various goals and personal risk-tolerances. Topics included in the webinar include:

  • Option basics
  • The 3-required skills
  • 4-practical applications
    • Traditional put-selling
    • PCP (Put-Call-Put or wheel) Strategy
    • Buy a stock at a discount instead of setting a limit order
    • Ultra-low-risk put/Delta strategy

Real-life examples along with rules, guidelines and calculations are included in this presentation.

Register for free here

 

2. Wealth365 Summit: Free Zoom presentation

Thursday April 7, 2022

11 AM – 12 PM ET

 

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Topics detailed in the course:

 

  • Option basics
  • Hypothetical and real-life traditional cash-secured put trades
  • Pros & cons of selling cash-secured puts
  • The 3-required skills for elite results
  • Delta defined and implemented
  • Real-life monthly cash-secured put trade with 6 income streams
  • BCI Trade Management System (first-ever such tool)

Register for free here

 

3.Long Island Stock Investors Meetup Group

Stock Options: How to Use Implied Volatility to Determine Strike Selection 

Creating 84% probability successful trades for covered call writing and selling cash-secured puts

Wednesday April 13, 2022

7:30 PM ET – 9:30 PM ET

 

4. LIVE at The Money Show Las Vegas

May 10th – 11th

Registration link to follow.

2 presentations:

Portfolio Overwriting (free)

Tuesday May 10th at 1:30 PM – 2:15 PM

Increasing Profits in Our Using Covered Call Writing

A Comprehensive Analysis of Covered Call Writing: 2-hour Masters Class (paid event to The Money Show)

Wednesday May 11th at 1:30 PM – 3:30 PM

How to master all aspects of this low-risk strategy

 

Alan speaking at a Money Show event

***********************************************************************************************************************

Market tone data is now located on page 1 of our premium member stock reports and page 1 of our mid-week ETF reports.

****************************************************************************************************************

About Alan Ellman

Alan Ellman loves options trading so much he has written four top selling books on the topic of selling covered calls, one about put-selling and a sixth book about long-term investing. Alan is a national speaker for The Money Show, The Stock Traders Expo and the American Association of Individual Investors. He also writes financial columns for both US and International publications along with his own award-winning blog.. He is a retired dentist, a personal fitness trainer, successful real estate investor, but he is known mostly for his practical and successful stock option strategies.

11 Responses to “Collar Trades: The Rationale for Maximum Gains and Losses”

  1. Sam March 5, 2022 3:48 am #

    Hi Alan,

    I was just wondering, do you have a few relatively safe bear market strategies?

    Thanks,
    Sam

    • Alan Ellman March 5, 2022 7:13 am #

      Sam,

      Glad to help.

      Below is a screenshot of a file listing bear market strategies detailed in our educational material. It includes the topic of this week’s blog article.

      CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.

      Alan

  2. Salim Sukkar March 5, 2022 6:19 pm #

    Hi Alan,

    I have a question about the mid-contract unwind strategy.

    Do you advocate unwinding a deep ITM position in the 2nd half of a contract cycle? If yes, and there are no viable new trades (not enough time value) for the current month, what should I do? My thoughts are that I could hold the cash until the start of the next cycle, or open a new trade early that expires the following month.

    I would appreciate your thoughts!

    Sincerely

    Salim

    • Alan Ellman March 6, 2022 6:47 am #

      Salim,

      The guideline for the mid-contract unwind exit strategy is to consider closing both legs of the trade if we can generate at least 1% more than the time-value cost-to-close.

      We use the “Unwind Now” tab of the Elite or Elite-Plus Calculators to assist in these decisions.

      If we cannot generate favorable net option credits, we take no action and continue to monitor the trade through contract expiration.

      Exit strategy opportunities can occur at any time. Although this strategy is generally reserved for early-to-mid-contract, there are times we can implement MCU later in the contract as I detailed in this publication:

      https://www.thebluecollarinvestor.com/mid-contract-unwind-exit-strategy-at-the-end-of-a-contract/

      Alan

  3. Barry B March 6, 2022 12:09 am #

    Premium Members,

    This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor Premium Member site and is available for download in the “Reports” section. Look for the report dated 03/04/22.

    Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them on The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:

    http://www.youtube.com/user/BlueCollarInvestor

    Best,

    Barry and The Blue Collar Investor Team
    [email protected]

  4. Marek March 6, 2022 3:05 am #

    Alan,

    I would like to ask a general question: when prior to the expiry of an option is the best time to roll out / buy back?

    The above question is prompted by my experience last week. I have sold cash secured puts for the following 3 underlying:

    NVDA – 225 put 03/04
    SQ – 105 put 03/04
    QQQ – 335 put 03/04

    As it turned out, all of the above underlying were hovering on Friday 03/04 around the strike prices of the puts I sold. I had a difficult time estimating if they finish out-of-the-money or in-the-money. Should I wait until the close of the market hoping they will expire worthless and risking being exercised (pretty desperate and dangerous – I think I answered my own question)?

    Or buy back / roll out, even though the premium is still high, as they are trading at-the-money (one of my at-the-money puts still had approx. $0.30 to $0.40 of time value just half an hour before the market close – at this stage I believe it was more “speculation value” than “time value”)?

    What would be your recommendation for such at-the-money scenarios: buy back / roll out towards the end of the trading on Friday, during the day, at the open on Friday, or perhaps even before Thursday’s close?

    Your advice will be greatly appreciated.

    Regards,
    Marek

    • Alan Ellman March 7, 2022 6:16 am #

      Marek,

      I generally reserve rolling an option to expiration Friday, a couple of hours prior to 4 PM ET. This is when the time-value cost-to-close is at its lowest.

      If we decide that we absolutely do not want to take possession of the underlying security and the share price is hovering around the strike price, we must buy back the short put. There is no way to guarantee that the strike will expire OTM. At that point, we can either roll the option or use the, now freed-up, cash to secure a different put underlying for the next contract cycle.

      Here is a link to a podcast I produced on this topic:

      https://www.thebluecollarinvestor.com/bci-podcast-53-itm-cash-secured-puts-allow-exercise-or-roll-the-option/

      Alan

  5. George March 8, 2022 3:54 am #

    Good morning Dr. Ellman,

    With everything going on in Ukraine, the markets seem to have to digest more and more bad news – higher oil, potential oil supply shortfalls if Russian oil is cutoff, higher raw materials cost for everything, humanitarian crisis, etc.

    You’ve stated in both of my books on Calls and Puts to favor slightly ATM and ITM strikes in a bear market. Well, this market feels bearish to me. But would you also recommend shorter holding periods than the standard one month option contract period?

    Just curious.

    George

    • Alan Ellman March 8, 2022 7:09 am #

      George,

      Trading in volatile market conditions is challenging and not for all investors. The Ukraine tragedy is impacting the market in a big way despite much of the economic and corporate news being positive.

      That said, for those of us who remain active in the market, there are many defensive approaches we can take advantage of. Here are some:

      Deep ITM calls
      Deep OTM puts
      PCP (put-call-put or wheel) strategy
      Collar strategy
      Ultra-low-risk Delta strategy
      Ultra-low-risk implied volatility strategy
      Use of more conservative underlying securities (lower implied volatility)

      Recently, I rolled-down several of my positions having had the 20% BTC limit orders executed. I even managed a couple of “doubles” like the XLP example shown in the screenshot below (note the classic V-shaped pattern).

      I have multiple option-selling portfolios. Most are dedicated to monthlys; a few to weeklys. Those remain intact regarding the expiration time-frames.

      Alan

      CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.

  6. Alan Ellman March 9, 2022 5:06 pm #

    Premium members:

    This week’s 4-page report of top-performing ETFs and analysis of the top-performing Select Sector SPDRs has been uploaded to your premium site. One and three-month analysis are included in the report. Weekly performance has also been incorporated into the report although not part of the screening process. Weekly option availability and implied volatility stats are also incorporated.

    The mid-week market tone is located on page 1 of the report.

    New members check out our ongoing and never-ending training videos (“Ask Alan” and Blue Hour webinars). We add at least one new video each month. Only premium members have access to the entire library of these training tools.

    For your convenience, here is the link to login to the premium site:

    https://www.thebluecollarinvestor.com/member/login.php

    NOT A PREMIUM MEMBER? Check out this link:

    https://www.thebluecollarinvestor.com/membership.shtml

    Alan and the BCI team

    • Alan Ellman March 9, 2022 5:07 pm #

      This week’s ETF Report identifies 29 ETFs that, not only have out-performed the S&P 500 in the last 1- and 3-month timeframes, but also are positive in the last 1-month.

      Alan

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