The collar strategy is a covered call writing-like strategy where a protective put is added to the covered call trade. In this article, the initial structuring of a collar trade will be highlighted using SLV, an eligible exchange-traded fund in our Premium ETF Report in August 2020.
The 3-legs of a collar trade
- STOCK: We buy shares (in 100 share increments) of a security that meets our system criteria
- CALL OPTION: We sell an out-of-the-money (OTM) call option to generate premium. This represents the ceiling of the trade.
- PUT OPTION: We buy an OTM put option to protect to the downside. This represents the floor to the trade.
Rationale behind structuring a collar trade
Simply stated, we want to generate cash flow. The stock is leveraged to generate option premium. Since we have a credit on the call side and a debit on the put side, we want call premium to be greater than put cost. As a guideline, we define our initial time-value return goal range for covered call writing and then reduce that amount due to the put debit. Let’s say our covered call writing stated goal is 2% – 4% per month and up to 6% in a bull market. For a collar trade, that would translate to 1% – 2% per month and up to 3% a bull market. We must establish a strategy goal prior to entering our trades whether it’s the one I am using for this article or another. It should be based on our personal risk-tolerance.
Real-life example with SLV
- 8/5/2020: SLV trading at $24.99 (long stock position)
- 8/5/2020: OTM $25.00 call (8/21/2020 expiration) generates $1.34 (ceiling)
- 8/5/2020: OTM $23.00 protective put costs $0.48 (floor)
SLV bullish chart in July – August 2020 (red arrow shows trade entry)
The BCI Collar Calculator
Initial calculation results:
- Initial 16-day time-value return is 3.44% (red arrow)
- Maximum return if SLV moves to, or above, the $25.00 call strike (can be called an at-the-money strike, $0.01 above current market value) is 3.48%
- Maximum loss if SLV moves to, or below, the $23.00 put strike is 4.52%
- These results do not reflect potential exit strategy opportunities. They are initial structuring calculations
Collar trades should be structured to generate cash flow. This means a net option credit. The initial time-value return goal range will be lower than that of traditional covered call writing due to the cost of the protective put. A guideline for our trade expectations is to generate at least one half of our traditional covered call writing initial time-value return goal range.
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Your webinar on 8/15 was fabulous, to the point,and very informative.
One question… could you clarify about when to buy and or sell your cc in and around ex d date
Again thank you for a great hour!!!!
Glad you enjoyed the webinar.
To avoid the rare possibility of early exercise related to ex-dividend dates, we write the call the day of or after the ex-date. The guideline is never to have an option in place that expires after the ex-date if it is critical to avoid early exercise. This is important if one of our strategy goals is to capture corporate dividends.
Thanks for the wonderful presentation. I wonder if you can clarify following.
1.For ex, in case of MSFT, Current price is 208.25, 2% premium will be 4.16, with respect to this premium, no strike price available at OTM in August, for September 4 expiration, strike of 212.50 has premium of 4.14., difference in strike price( 212.50/208.25) is 1.08% and probability of assignment is close to 100%. How it can be avoided?
If you are further out of the money strike price, your premium percentage keeps on reducing. I am not clear if it can work on weekly or monthly basis.
What relationship you can compute between strike prices and premium.
Thanks for attending our webinar.
The probability of assignment without exit strategy maneuvers (like buying back the option) can be measured with Delta. This is the probability of an option expiring ITM at expiration. For the OTM strikes that I alluded to in the webinar, the Delta is less than 50%. Some vendors like CBOE.com will give Delta stats for each option as shown in the screenshot below.
As MSFT is currently trading at $208.50, the 1-month (9/11) expiration for the $212.50 strike generates $5.00 or 2.4%. The Delta is 41.8%.
If the strike is expiring ITM, we can roll the option or allow assignment depending on whether we decide to keep this stock the next contract month.
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I enjoyed the BCI zoom presentation Thursday evening! You did a very nice job. Thanks.
I do have one question from the zoom call. If we want to get 3 income possibilities, one of them is the dividend. How can we be sure to get the dividend if we avoid options that cover the ex-date?
Best to you,
Thank you for your generous comment.
When we avoid selling the option until the ex-date or later, we still retain possession of the stock or ETF. By owning the stock on the ex-date, we are ensured of capturing the dividend. On or after the ex-date, we then write the covered call which represents the second of the 3 income streams.
I enjoy your knowledge and education. I’m in Melbourne Australia and glad to have found you about a year ago. I believe you have a man in Australia.
Have you heard of a strategy called the “Option Wheel”? It appears to be a combination of beginning with a Cash Secured Put until assignment and then Covered Call until assignment and repeat!
Theoretically it seems valid but my concern is whether it would be a losing strategy if the instrument continues to fall vs a buy and hold or BCI strategy.
Have you backtested such a strategy?
I’m familiar with this strategy. The Wheel strategy is essentially the BCI P-C-P strategy with a different name, same structure. You can learn more about this strategy in Alan’s book “Selling Cash-Secured Puts”. There is another version of this strategy that uses a Bull Put Spread to initiate the trade instead of just buying a cash-secured put. But this approach is beyond the scope of this article because it requires a higher level of options trading permissions from your broker.
If the instrument continues to fall, by buying the put, your worst-case loss is defined at the time that you place the collar trade. As a matter of fact, I use collars for all of my trades when I go on vacation or any time that I can’t be near my computer for an extended time.
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 08/14/20.
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Thank you Alan, I enjoyed your recent 3-Income Stream Strategies video.)
I do have a question.
Because most options expire OTM, do you cancel your 10% BTC ~5 days prior to expiration? Otherwise, aren’t you are just incurring an additional cost without much benefit?
I will generally leave the 10% BTC limit order in place. Although the time-value is eroding rapidly, we may have rolling-down opportunities.
I recently published trades I executed where I rolled-down twice in the last 2 days of a contract and one where I actually “hit a double” on the last day of a contract with QQQ.
This approach is especially useful in volatile market environments.
Check out this article I recently published:
If the election results can cause a sharp decline in the stock market, is it a good idea to stay on the sidelines until after the results are in and we can better evaluate the situation?
This is up to each investor’s personal risk-tolerance. In 2016, I did move into cash prior to the election and re-entered a few days later. I will probably do the same this year. I view it in much the same way I view earnings reports but this one impacts the entire market.
Another approach is to use collar trades for the November contracts.
Also, keep in mind that there are now “circuit breakers” built into mitigating against catastrophic market declines:
Level1: Market halts for 15 minutes if S&P 500 declines 7% from previous day’s close.
Level 2: Market halts for 15 minutes if S&P 500 declines 13% from previous day’s close.
Level 3: Market halts for the remainder of the trading day if market declines by 20% from the previous day’s close.
Levels 1 and 2 halts do not apply after 3:25 PM ET.
In 2016, the market spiked up after the election despite the futures being down huge overnight. However, I did not have to reach for my box of Kleenex as i realized that it was the right decision for me. Each investor should evaluate the facts and come to a decision that aligns with their personal risk-tolerance.
Alan and Marsha,
It’s natural for us to be apprehensive about an upcoming presidential election.
I, too, remember in 2016 at 4:00 am the Dow futures being down 900 points only to see the market rally 300 points at the open and close up 250 points.
But the data show a different picture. According to Matthew Maley, lead strategist at Miller Tabak + Company, we shouldn’t be that worried. Below is a quote from an article in “MarketWatch”.
“History is also a factor, with the U.S. presidential election looming. He notes the stock market has rallied from Election Day (or shortly thereafter) until the end of the year on 10 of 12 past such occasions since 1972, with an average gain of 7.2%. And that rally will come “no matter who wins the election in November,” he says.”
The entire article can be viewed at:
I think I will prepare my portfolio to be bullish from the election to year end. Just one guy’s opinion. I’ve been wrong and I’ve been right. It’s at lot more fun when I’m right. I was wrong at the end of March this year. I bet against a V shaped market recovery and lost. I thought I was too old to recover from my portfolio losses in the Great Recession, but I was wrong then too. I didn’t sell then and it really paid off big time. I am not saying that one shouldn’t be cautious, but being out of the market on just a few days of the year can greatly affect your portfolio to the downside.
Lastly, almost all Bear Markets are fairly short term. The long term trend has always been up. Those who have bet against this have had their “portfolios” handed to them on a platter.
Members and followers of BCI can be, and usually are, better prepared for the ups and downs of the market.
Thank you Alan and Hoyt. I have read that Trump is more business friendly than Biden and if Biden wins if the market will react negatively. I have heard predictions both ways. I guess we’ll find out soon enough.
Good luck to all.
I hope all is going well with you.
Let me suggest another line of thought…BTW, this is NOT a political commentary…
With the volatile political season and the volatile geopolitical climate, you might want to think of a potential “October Surprise”. With the pandemic issues, the hot rivalry between the parties, the China situation, the mid-east situation, etc., this election season is very different than others we have gone through in the past.
My concern is the time period between mid-October and just after the election. Hence Alan’s comment on “collaring” our trades makes incredible sense. In my case, i’m willing to give up some upside premium to have my downside better protected.
Just a thought…
Great to hear from you. All is well with me and I hope it is with you also.
Good idea about the collars! Alan and you are absolutely correct.
And there will be an October surprise. An indictment of Biden, possible arrest, Martial Law, Atomic bombing of China and return atomic bombing of us, possible assassination attempts, fake assassination attempts, all kinds of true and fake accusations, and/or COVID-19 contraction by either candidate.
Hey, I may have talked myself out of even being in the market past September.
Hope you are keeping well.
I watched the 3 way income webinar – it was great, thank you.
I also reread the exit strategy book…. and wondered..
When the stock price goes up and on Expiration Friday, yes I can do your calculator What Now… then work out the best solution,
but how about buying back at 20%, or 30% or something? .. when the stock going close to / above strike price. Buy back cost is too expensive on near or expiration day.
Would it work? I haven’t tried it but since you have been doing this for a long time, I thought you may have tried it..
Or is that your mid term unwind one.. aghhh I am so confused right now.
I know the easiest thing is to do “no action” and let it called away.
Please let me know what you think.
You’re doing great… don’t beat yourself up. Your mindset is in managing your trades which puts you way ahead of most option-sellers outside the BCI community.
The question is whether there is an exit strategy opportunity when the strikes moves deep in-the-money on expiration Friday. You alluded to 3 exit strategy considerations:
1. 20%/10% guidelines: These guidelines do not apply. They are used when share price declines.
2. Mid-contract unwind exit strategy: This applies mainly early-to-mid-contract, not on the last day of a contract because there is no time-value opportunities.
3. Rolling our options out or out-and-up: Here, the % cost-to-close compared to the original option sale is not relevant. We compare the time-value credit compared to the original strike price to see if the time-value returns meet our stated goal range.
First, we must determine if we want to keep that stock in our next-month contract portfolio (no earnings report etc.). If the answer is yes to both, we roll the option. Use the “What Now” tab of the Ellman calculator to make these determinations. If not, take no action.
Keep up the good work.
Thank you for your reply Alan.
Sorry I think I didn’t explain well…
Assuming I am not keen to hold stock,
(Just aiming to collect premium, get money back and go again)
A stock… let’s say the stock was going up, and my covered call premium was showing -30 or – 50%.
So let’s say premium was $5.00, as the stock was moving up, the buy back cost was 30% or 50% more than the original cost such as $6.50(30%) or $7.50(50%) to buy it back.
So at this point, when I could clearly see it’s very bullish, would it be better to buy back at 30, 50% , rather than surpassing buying back at 80% or more on near or on expiration day?
I have bought some back in the past, from the fear of buying back at much more expensive cost, then sold stock.
But unsure if it was the right thing to do 🙁
I have been practising rolling and all sorts..
Kind of feeling stuck.
You have 20/10 rule for declining stocks, so I wondered if you have something similar for increasing stocks PROIR to expiration Friday?
BTW I have “Expiration Friday Flow Chart with some possible exit strategies” and “Pre-Expiration Friday Flow chart”. printed out and refer to it often. Very handy, thank you.
Let me respond from 2 perspectives:
1. If you do not want to retain the stock and the time-value cost to close is greater than the time-value that can be generated by contract expiration with a new stock, take no action and the shares will be sold the day after expiration.
2. We do have an exit strategy when share price rises substantially…the “mid-contract unwind” exit strategy. Here is a link to an article I published several years ago:
This strategy is also detailed in both Encyclopedias and in the covered call writing online streaming DVD program.
so yesterday my ADBE 08/21/2020 440.00 P BTC order was executed at 10% of the original premium since I left all my BTC 10% orders in place. I am very happy with the 2.6% gain.
Now my question is: what to do with the freed-up cash?
The 08/21/20 expiry is too near for a decent CC ROO, and 09/18/20 is a bit far, for my taste, but with ER season almost over, maybe the premiums would be attractive?
Would you reallocate your cash immediately?
Congratulations on this successful trade.
In cases like this, I will look to see if there is a rolling-down opportunity. If the shares were sold, I would keep the cash on the sidelines until Monday. Not much additional time-value premium to justify taking on an additional weekend risk. I also like to take advantage of the new weekend stock report to make my selections.
Thank you Alan,
My instinct was the same. I always like to see the new weekend stock report before entering the Monday post expiry trades for the new cycle.
I have a question regarding PMCC and ex-dividend dates.
I have PMCC on KO expiring 9/11. KO goes ex-dividend on 9/14 (Monday), so if short call will be ITM I need to buy it back a day or few before 9/11 to avoid early assignment. I assume I can’t wait until 9/11 because most likely it will be exercised that day.
Another option is to roll the short call out to further week, let’s say, 9/18 or 9/25. But what will happen to LEAPS then? When our short call is covered by stock (covered call), we will capture dividend generating the third income stream, however with LEAPS it’s opposite… If I get it right on ex-dividend date the LEAPS value will decrease by the amount of dividend.
So my question is, does it makes sence to roll out ITM call to avoid early assignment when trading PMCC?
Yes it does as long as our bullish assumption is still in place.
Now, this is an interesting situation in that the ex-date is on Monday 9/14. The most likely reason for early exercise is the ex-date and, IF it occurs, it will be the trading day prior to the ex-date which, in this case, is Friday 9/11. This is also the date of the contract expiration. So there are 2 competing issues: avoiding exercise due to the ex-date and the ITM short call.
The best way to manage this scenario is to roll the option in 2 stages:
1. Buy back the near-week short call on Thursday
2. Re-sell the later-date option on Monday or Tuesday.
I hold a QQQ Aug 21 260 strike. It is deep into the money and I want to keep trading the QQQ as part of my portfolio. On Friday I want to roll out and up to an out of the money to a Sept 18 call. I am still bullish on the QQQ’s so looking at the 285 -290 strikes. Your book advises not to roll up and out but I am now lagging too far behind when I keep rolling out and up to in the money strikes.
The delta on the 280 Sept 18 strike currently is .48 and the 290 strike is .26. My goal is to keep the QQQ and generate cash with out of the money strikes eventually. I have enough cash to do this now but won’t if the market keeps up this rate.
Alternatively I could roll out and up to an at the money Sept 18 strike for a smaller debit but I am concerned that I will not be able to start generating cash and stay in the QQQ.
Donna L, a premium member
Many of our BCI members hold positions with QQQ and that pleases me. As I type, QQQ is trading at $278.58 and the “ask” price to close the $260.00 call is $18.69. That translates into $0.11 per-share in time-value. Minimal time-value cost-to-close is typical for deep in-the-money strikes.
Use the “What Now” tab of the Ellman, Elite or Elite-Plus Calculators to evaluate the rolling out-and-up returns. The screenshot shows the results if we roll out-and-up to the $285.00 strikes with current published premiums.
The calculator shows a 1.61% initial 1-month time-value profit with an upside potential of another 2.47% for a total possible 1-month return of 4.08%.
Use this tab of the calculators to analyze other strikes to see which meets your needs.
CLICK ON IMAGE TO ENLARGE & USE THE BACK ARROW TO RETURN TO BLOG.
I’m sure I just missed it but my understanding was that we leave 3-4% of our portfolio in cash to enable buying back calls that have gone in the money when we want to keep the stock or quickly liquidate a position that is moving against us.
However, I see that Alan has 50% of his portfolio in an interest-bearing account.
1.) Is there a table of how much money to keep on the side depending on market conditions? With percentage ITM/OTM?
2.) Doesn’t this half the expected return of the portfolio? Or in a an up market are we supposed to see more income by
selling a mix of ITM and OTM calls, with the cash giving us a cushion?
3.) What is this interest-bearing account? My credit union pays a bit over 1% but this is about the best there is nowadays
without taking on credit risk.
I am almost always 100% invested with the cash I have allocated to the stock market. My current 50% position is an aberration and related to my concerns over the impact COVID-19 will have on our economy. I don’t tell others what to do but I’m happy to share what I’m doing and why.
The cash is left in the broker interest-bearing account. True, we need a magnifying glass to identify the amount of interest generated but I want the cash ready to be put to work when there is more clarity on the situation.
I also share my percentage of ITM and OTM strikes I am using in our weekly ETF and stock reports. Currently, I am favoring OTM strikes 2-to-1 compared to ITM strikes. I will evaluate my mix over the weekend for the upcoming September contracts.
In normal market conditions (which is 99% of the time), we leave 2% – 4% of our portfolio cash on the sidelines and available for exit strategy opportunities.
Thank you very much for getting back to me so quickly and explaining your 50% cash position.
I glad to know I wasn’t misunderstanding an important part of your system and that the 50% position reflects the uncertain
Thank you again and stay well!
Quick Poor Man Covered Call question:
I thought I had read in your book Alternative Strategies (I now cannot find that segment) that you recommend NOT selling ITM short calls on a LEAPS and if true, may I ask for the quick reason for it so I can comply accordingly?
You are referring to the Poor Man’s Covered Call (PMCC) strategy, also known as the “long call diagonal debit spread” This is a long-term strategy where we look to generate cash-flow leveraging deep in-the-money LEAPS options.
We favor out-of-the-money strikes with this strategy for 3 reasons:
1. Allows for additional income due to share appreciation up to the OTM strike.
2. Decreases the possibility of option exercise.
3. Decreases the need to roll options.
Like all strategies, each investor can craft the terms of execution based on strategy goals and trading style. In my books/DVDs, I offer traditional approaches to the PMCC strategy.
today, for the first time since I started trading CC options in 2015, my OTM MSFT 08/21/2020 205.00 C was assigned before expiration.
I am very happy about it because it brought in a 4% gain, (premium 636.00+183.00 share appreciation, total 819.00). 🙂
My buyback order of 10% (limit $0.65) is shown as “cancel pending” in my “today’s trades” Schwab page.
I believe it makes sense for the buyer of the contract because MSFT was trading at approx. 212.00, and probably made a profit for him, or for any other reason.
I am sharing this absolutely new experience with our members because I have seen many questions about an early assignment on this blog in the past.
Nice work! I’ve had early assignment a few times…the most recent time this morning. I love when this happens…hit my upside targets and get out early.
I loved it too. Wish it happened more often to me.
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Alan and the BCI team
Hello BCI Staff:
I read somewhere that “covered call writing will outperform stock ownership in any market except a strongly rising one.”
What are your thoughts?
I strongly disagree. Covered call writing can be crafted to take advantage of all market conditions. We do so by mastering the 3-required skills… stock selection, option selection and position management.
A few examples for managing in a bull market:
1.Allow a higher initial time-value return goal range. This allows us to use higher-implied-volatility securities.
2. Use deeper OTM strikes to accommodate more share appreciation opportunities.
3. Be prepared with appropriate exit strategy executions for bull markets (mid-contract unwind exit strategy).
For years, the information provided on covered call writing stated that it was appropriate only in neutral markets. In my humble opinion, that is information appropriate only for the closest incinerator.
Thank You. Your wisdom, knowledge and experience is duly noted.
And I appreciate it very much.
Hello Alan and the BCI team,
i was not able to attend the webinar on 13 (living in china, time difference not convenient for me). Any chance there is a replay available ?
Sure, here is the link:
G day Alan.Just a quick question on option chains.
Firstly what is implied volatility?
Who makes up the option chain figures and what determines these figures ?
Implied volatility (IV) is the market forecast of a stock’s volatility (price movement) based on the option pricing in the marketplace. Vendors generally provide this stats based on a 1-year time-frame and 1 standard deviation (accurate 67% of the time). IV is directly related to the amount of our option premiums.
Option-chain information is provided by the option exchanges and disseminated by various vendors, including all brokerages. A reliable free site for option chain information is http://www.cboe.com.
The information published is based on best buy and sell offers.
I’ve be selling puts for awhile now, purchased your book a few days ago and plan on becoming a member this weekend.
I had a strange occurrence today. I sold a couple Target puts last week. With Wednesday’s earnings I planed to close out the options on Wednesday.
To my surprise, even though Target stock was up $17, my one put that became way out of the money, lost money. I initially figured by the end of the day it would fix itself but it never did.
When we sell a put, we keep that entire premium no matter what the value of that put is in the future.
In the case of TGT, there are 2 factors at work that explains the loss in value of the put:
1. Share price accelerated: Put value is inversely related to share price.
2. The earnings report passed: This resulted in a decrease in the implied volatility of the stock. This is fairly typical or pre- and post-earnings option pricing.
This scenario should cause us to recognize a potential exit strategy opportunity. Review pages 141 – 143 in my book, “Selling Cash-Secured Puts” where the 20%/10% guidelines are detailed for put-selling (different for covered call writing).
What you experienced is called “Volatility Crush” and can be caused by the factors that Alan mentioned.