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Generate Income Trade Options
Options’ trading offers the opportunity to investors, to fully protect their long stock portfolio, using what is known as a Costless-Collar strategy. The idea is to provide hedging on the long stock held, without paying a net premium for it!
This is a rather sophisticated option trading idea, though there’s nothing strange about it in theory, it does require making use of long term options, (LEAPs) for best results.
(LEAPs are options with very long expiry terms, that can be up to 3 years)
Payoff diagram of the costless collar strategy:
Notice how it compares to the simple covered Call writing strategy, the costless collar doesn’t lose money, no matter what happens!
Suppose an investor owns 100 shares of given stock, in principle, all that’s required to make a Costless Collar is to write 1 OTM LEAPs Call and to buy 1 ATM LEAPs Put.
Assuming the shares are trading at $50 today, and that the investor is rather bullish on the stock, so wants to keep them for another year or so, he also wants to be 100% protected in case the stock drops.
Both options have the same expiry date, the investor here only writes the OTM cheap Call and using the premium collected, he buys the most affordable ATM Put. The Delta implication of this (one option being OTM and the other being ATM) is that if the stock drops, the Put Leap option with its higher Delta will make a lot more money than the low Delta, OTM Leap Call would lose if the stock rallied by the same amount!
In this hedging strategy, the investor is protected no matter what happens. It costs almost nothing to set up, if the stock drops he makes up the loss from both the written Call and much more from the long Put. If the stock rallies, the profit becomes limited at some point, theoretically at least. But remember that if the stock does rally this much, by the time the stock is at say $58, he might as well get rid of both options, and set up a new costless collar at a higher, more relevant price level! (You can always buy back a written option) You have to realize that this is theoretically shown to fully hedge a long stock for up to a given price projection of stock rally, and for any amount of stock decline. In this example the free hedging occurs from the $50 to $60, beyond the $60 level no profit is made. But like I said, you can always close down the old costless collar and setup new ones, so that you always maintain a $10 margin of free hedging!
Once again, volatility is a huge factor in making sure we can get good premiums for the written and long options. Analyzetrade.com offers an extensive array of tools and back-testing facilities that will enable you to fully test, and simulate such hedging strategies, using actual market data. You will be amazed to find out how relatively simple option trading strategies can be used to hedge long stock positions, and how the losers of the dot-com crash could have eliminated ALL market risk if they were option savvy…
Analyzetrade.com can help you achieve trading success, as well as provide you with a full option trading mentoring program that will set you years ahead of other traders!
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