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Study Confirms What We Already Knew

The Performance of Options-Based Investment Strategies:
Evidence for Individual Stocks During 2003–2013

Link to full paper


Using data from January, 2003, through August, 2013, we examine the relative performance of options-based investment strategies versus a buy-and-hold strategy in the underlying stock. Specifically, using ten stocks widely held in 401(k) plans, we examine monthly returns from five strategies that include a long stock position as one component: long stock, covered call, protective put, collar, and covered combination. To compare performance we use four standard performance measures: Sharpe ratio, Jensen’s alpha, Treynor ratio, and Sortino ratio. Ignoring early exercise for simplicity, we find that the covered combination and covered call strategies generally outperform the long stock strategy, which in turn generally outperforms the collar and protective put strategies regardless of the performance measure considered. These results hold for the entire period 2003–2013 and both sub-periods 2003–2007 and 2008–2013. The findings suggest that options-based strategies can be useful in improving the risk-return characteristics of a long equity portfolio. Inferences regarding superior or inferior performance are problematic, however, as the findings reflect the Leland (1999) critique of standard CAPM-based performance measures applied to option strategies.

Evidence (charts based on data that goes back to 1986) that buy-write strategies (BXM) and put-writing strategies (PUT) outperform collar strategies (CLL) and simple buy and hold is widely distributed and well understood by experienced option traders. Those studies are based on index options and the study quoted above concentrates on individual stocks. But the conclusions are familiar.

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Danger: Using one trade to finance another

This is a continuation of an ongoing discussion in the comments section. It all refers back to a post from July 2009.

It began with a comment on this post where Mr X (who manages other pepole’s money) proposed the idea of buying a more useful put (i.e., one with a higher strike price) when constructing a collar. Because that ‘better’ put is more expensive that the traditional put (some small number of strikes out of the money) he included the suggestion of financing that more costly collar by selling a put that is farther OTM than the put owned.

In other words, instead of buying a put that affords 100% protection (after paying the deductible) for the other part of the collar (the long stock/short call portion), he proposed buying a put spread. The idea is to buy an ITM put and sell a put that is 20 to 30% out of the money. He provided statistical data that shows that this was sufficient protection more than 99% of the time. That is reassuring evidence for a trader, but the investor who wants the complete protection of a true collar (think Black Swan), this may not be sufficient protection. It is, however, a reasonable choice for someone to consider.

Quoting Mr X:

So you can actually buy a vertical (buy PUT at the money, sell a PUT 20 to 30% lower). This reduces your protection (can still have a major black swan though), but historically it still protects you against 99% of the market drops. And the cost is cheaper (we are saving 20-30% or so on the cost of the protection).

Bottom line: less costly collar, good enough to work 99% of the time (looking back in time does not mean the same results will occur in the future). As I mentioned: a reasonable alternative. The trade is made for a good reason: It costs less, adds to profits (lower cost = higher profit), and is good enough almost all the time. It’s a very attractive idea – for the more aggressive trader.


The trader has two choices:

  • Own the traditional collar with an (perhaps 5%) OTM put
  • Own a collar with zero deductible (ATM put)
    • This comes with no Black Swan protection

This was my reply at the time:

Overall, I do like the idea of owning the ATM put. But this will not satisfy everyone’s comfort zone. Is it better to avoid the 5% deductible and give up black swan protection? Not an easy decision.

And that was where we left it. An alternative that works better than the collar most of the time, but which leaves the investor facing the possibility of a financial disaster if a true Black Swan event occurs.

That discussion was re-opened recently when a reader commented on the ideas of Mr. X.

One thing led to another and the discussion reached a level where I felt it necessary to post this for other readers.

It is easy to fall into trading traps, and the one discussed by my correspondent is one of those slippery slopes that can lead to blowing up an account. Below is an abbreviated version. The original comment is here

In my mind, this is the progression of a trader:

Step 1: One learns about a put, so they’d like to purchase a put to protect a long position.

[MDW. This trader is off to a very bad start. Learning about puts is not a good reason to buy them. And this really upsets me. One does not BUY or SELL something that is not yet understood. Puts are too expensive for most people to own. It essentially kills any chance to earn profits.

Step 2: To help finance the put, they sell a call, thus they have a collar. They’re willing to part with the stock at the call strike.

MDW: True, it’s a collar. But look what you just did to this poor trader who owned some stock. He ‘learned about’ puts and bought some. Then he sold calls to create a collar. We don’t know that this trader wants to own a collar or even knows what a collar is. This is blind trading for no reason. You are suggesting that this is a ‘step’ in becoming a good trader: Buy a put because the trader learned that they exist (why did he buy and not sell?) and then sell calls just because the trader owns stock and is willing to sell. Two foolish trades. Two steps backwards in an options education. I don’t like being so hard on a loyal reader, but this is not progress.]

Step 3: Like in step 2, they want to help finance the position, so they think of selling a put on the same stock. (this is where you and I agree that this may not be a good idea)

[MDW: I don’t see how this is progress. If the trade is made ONLY to finance the original trade, it is foolish. The discussion you are quoting does not adopt this strategy. Making trades for the sole purpose of raising cash is the (short) path to eventual ruin.]

Step 4: They realize that selling a put on the same stock may not be a good idea because they don’t really want to own it at that strike price.[MDW: Why does the prospect of buying stock at the put strike price occur to you? Not every put seller wants to buy stock. Most traders would cover the put at some future time, rather than take ownership of the shares. There is no indication that the put sale was made for any other purpose than making a trade: Give up the regular collar with its deductible and trade it for a collar with no deductible, but only limited protection. Why is that bad? When I agreed with you originally, I missed the point that Mr X was buying a better put.]

Essentially, they want to sell the put for the wrong reasons and they’re exposed if the stock drops below that lower strike (I think this is where we’re agreeing). [MDW: Not when you explain it this way. In fact, this trader has an excellent reason for selling the put. It lowers costs and leads to profits >99% of the time. What better reason does a trader need, as long as he keeps risk under control by trading the appropriate number of contracts?]

Thus, they try to think of other ways to finance.

[MDW: Why do you believe the trader is seeking other ways to finance? He found a perfectly acceptable method]

Perhaps they could just use existing funds they already have, or they could use the premium from other positions that they would like to own, like by shorting puts on stock B which they are intending to invest in.

[MDW: This trader does not seem to be someone who has any interest in buying any stocks so why would he want to sell puts on stock B? Selling them just to finance another trade is a very poor idea.]

So that’s my thought process of how one gets to this point. The journey doesn’t seem that unreasonable even if individual steps may be ill-advised (i.e. step 3).

[MDW: To me, the journey is dangerous – with each step leading the trader closer to ruin. I do not expect this trader to survive very long]



The big issue for me is that you actively seek ways to ‘finance’ trades. That is a slippery slope that leads to taking far too much risk. If a position is not good enough to own on its own, then it does not belong in the portfolio. It does not have any ‘need’ to be financed.

How does financing the position make it any better to own? Portfolios should be managed by risk and not by how much cash can be collected to finance other positions.

Sure, some trades provide cash that can be used to meet margin requirements of other trades. But making those trades just to generate cash is not smart.

I understand your thinking: If a trader can finance his trades by making other trades that he truly wants as part of the portfolio, that’s a good thing. It keeps the account stocked with cash and eliminates the need to borrow money from the broker.

Look at it from a simplistic point of view. The trader has some positions He seeks to finance them by opening more positions, each of which comes with a net positive cash flow. In other words, the trader sells option premium. Each of those trades involves risk.

It takes a very disciplined trader to recognize when enough premium has been sold. It’s important to prevent over-selling. Once the idea of selling more options to finance other option positions takes hold, it is almost impossible to stop. It will appear to be free money – until the account blows up in one devastating moment.

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The Stretched Collar, Again

Thanks Mark for your prompt reply. After reading two of your books and this blog, I must say that options trading is becoming less scary and more appealing to me, so thank you.

Amir, “Less scary” is very good. But please do not become overconfident.

I’ll explain my logic regarding my second question – buying longer term put option (6 month for example) and selling monthly call option against it in a collar strategy.

I trade index futures, Emini S&P (symbol: ES) and Emini Nasdaq (NQ). The CME provides margin discounts for Inter Commodity Spreads

I believe that the Nasdaq will outperform S&P – so I’m long 2 NQ and short 1 ES (that’s my “portfolio”). Now lets add the options to the soup as follows:
Sell 2 OTM CALL (NQ)
Buy 1 OTM PUT (NQ)

The credit from selling 2 calls will cover the cost of the put.

I need a bit of clarification. I assume you mean that after selling the calls every month for for six months, you will collect more than the cost of the put. Or, are you telling me that you will collect that much the first month?

Does the basic risk as you explained (the very expensive put loses so much money, that it kills my whole play) apply to this situation too?

If the market drops, 1 Emini Nasdaq contract is protected by the put option and the second Nasdaq contract is hedged via the short Emini S&P contract (value of 1 point NQ is $20; value of 1 point ES is $50).

What do you think? can it work?

Thanks again



Hello Amir,

When replying to reader questions, I don’t know anything about the trader. Sometimes I receive very sophisticated questions from someone who doesn’t understand what he is asking. At other times, I must be careful not to provide a rookie answer to a more sophisticated trader. It makes it difficult.

How long have you been trading? Have you been using options for a few years, or are you in the very early stages of learning? I ask because you are not using an ordinary strategy.

This question is difficult to answer. Many factors are in play. If you are a rookie, I would tell you that this is too complex and that you should get your experience with a simpler approach. On the other hand, if you are an experienced trader with experience trading this setup, then I’d be encouraging you to continue.


Almost anything ‘can’ work

The question is whether this (or any other) play has an appealing (to you) risk/reward profile.

I’ll offer comments. Use anything that’s appropriate and discard any ideas that don’t apply to you.

This position feels delta short and would not do well in a rally. The collar trade that you appear to be emulating performs much better (than this trade) when the market rallies.

1) I assume you understand the vega risk of this position. You own lots of vega from that long-term put. If the market rallies you would be in trouble. Let’s look more closely.

a) This position is naked short 1 ES contract. Yes, it appears that you own 2 NQ minis, but by writing covered calls, the upside is limited. There is nothing worse than being naked short calls (or stock or futures) in a big rally.

b) You are short 2 NQ ITM puts (equivalent to the two covered calls). Those will make good money on the upside, but the profit potential is limited. It is not enough to offset the naked ES short – on a big up move.

c) Owning an OTM, longer-term put would not only lose money on that rally, but the likely IV crush translates into an even larger loss. True you sold two shorter term options (you may look at them as either the covered call, or the naked put) – but that single, long-term put option has more vega that these two options combined. That is not good on the upside (and it’s not so good on the downside either)

The upside is risky

I understand that the delta of this position depends on which specific options that you traded, but this feels short. If it is neutral, it would become short quickly due to negative gamma.

2) What I do not like about that play is that you do not know where the market will be when it’s time to sell the next round of calls. I know that it should not matter because once expiration has passed, wherever the market is as that time, you are long 2 NQ and short 1 ES and that you can afford to write to call options. But that put option makes a big difference.

What if the market moved higher, that put is now farther OTM and offers less protection. In fact, it may soon become nothing more than disaster insurance.

That’s not a realistic collar – because the put is supposed to provide good protection because it is not far OTM. In your trade, that long put is a play on volatility. You are depending on a big IV increase to protect the value of the portfolio. Most collar buyers rely on gamma – or the fact that their long options gain delta very quickly when they move ITM.

It’s acceptable to trade vega for gamma, but it is far from riskless. I get the fact that theta is on your side and everyone loves positive theta. however, its buddy, negative gamma is where the risk lies. This position requires careful handling and adjusting if the market continues to move higher.

How far OTM is too far OTM for you? At some point you may be forced to roll that put to a higher strike? When would you make this trade? How much cash are you willing to invest? Whatever you decide, write that sum into your trade plan so you can remember to do it when the time comes.

It’s difficult to gauge such costs when you would must estimate a market level and an IV level to estimate the cost.

3) Yes: In this play the 6-month put loss could make this whole play a loser. As already mentioned, you have upside risk outside that put.

Use ‘what if’ software to examine the value of the portfolio at different prices, IV, and dates. There is no need to make this into a guessing game. You can gauge risk/reward and see where your risk lies much better if you take a look at some possibilities.

4) The downside appears to be better.

a) 2 NQ vs 1 ES ought to be a reasonable hedge – when we look at the $20 per point vs. $50 per point comparison. If NQ does not decline by more than 50% as much as ES, you are in good shape. Please remember that NQ is far more volatile than ES, and I don’t know whether 2:1 is the right, market neutral hedge. If you get the hedge right, then you will prosper if NQ outperforms.

b) You own a naked put option. That’s good in a decline.

c) You are long vega and that should be good, but not always. When IV explodes during a violent market, it’s the near-term options that explode the most. In other words, the big IV increase provides a good bonus for the price of your long put, but it’s possible – depending on time to expiration and just how much the IV jump in the front-month options exceeds that of the longer-term option – that you can lose money from the IV surge.

I recognize that you are short front month calls, and not puts, but they may not decrease in value (as the market falls) by enough to do contribute to the portfolio value. Against that naked put, you own 2 NQ vs being short 1 ES, and this is a bearish play.

One more point. This is a convoluted trade and I may not be correct in my analysis. If you want a collar, I think you should trade a collar equivalent (sell a put spread).

I am not comfortable enough with my analysis to give you advice. It just feels to be a bearish trade. You must run the risk graphs, and your broker may offer suitable software. Ask. The computer will give you a much better picture of risk than I can.

If you do that, I’d like to see one of those risk graphs.

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Buying Call Spread vs. Writing Covered Call Calls


I enjoy reading your blog for quite some time now. I’m very glad I found it as it helped me clarify a lot of things regarding options. So thank you for that education.

Because I wanted to know more details especially for risk management and proper trade execution I recently bought your two books Create Your Own Hedge Fund and The Rookie’s Guide to Options. In both books you are explaining conservative strategies as Covered Call, Collar and Writing Cash Secured Put.

I’m trying to test them via Paper trading. However I would like to ask you something related to cash secured puts. When you enter this trade you are bullish. As with covered call you are carrying significant risk when market goes down.

You don’t have to be bullish. All that’s necessary is that you are not bearish. Neutral markets are also good for these strategies. But yes, there is downside risk. No question about that.

One way to protect against such “big” loss seems to me might be to enter vertical bull spread instead. I guess this will be somehow counterpart of collar for call side. I’m wondering why such strategy is not listed in the conservative list of strategies. Is it because it is not income efficient or I’m I missing some other point?

You are not missing anything. If you buy a call spread, (or sell a put spread with the same strike prices), that is equivalent to a collar – same risk, same reward – but much easier to trade. It’s apparent that you already understand that.

The reason this idea was not included in the earlier book (Create) is because of what I was trying to do with the book. The idea was to get readers started using options. I decided that including many examples would be better than adding additional strategies. There is another reason. Many brokers consider spreads to be ‘complex’ and ‘complicated’ and they do not allow their less experienced traders to use spreads. Ridiculous, I know. However, that’s the way it is. So I kept it simple in the first book. In the Rookie’s Guide, the chapters on equivalency and credit spreads make it clear that these trades are all equivalent (sell put spread, buy call spread, buy collar).

The reason for not including ‘debit spreads’ and only writing about ‘credit spreads’ is that the vast majority of traders prefer the spread in which they collect cash, rather than spend cash. We know they are equivalent trades, but sometimes certain trades just ‘feel better’ – especially when the trader has not yet learned that the trades are essentially interchangeable.

I agree that adopting one of these spreads is far (far) less risky than the covered call or cash-secured put. The reward is also less, but I believe it is a good trade-off to take the safer route.

Based on stated above I “tested” such approach last Friday on weekly option with Ford stock (Friday close price 16.27). I sold “Feb 4, 16P” for 0.16 and bought protection “Feb 4, 15P” for 0.03 (i.e. net credit 0.13 which is 0.8% of 16 strike price with DP – downside protection, or downside break-even, 15.87 for week. In theory, for a month I can get 3.2% ROI on weekly – I know this is ideal thinking but much better return than regular monthly option approach. On monthly Feb 18 and same strike bull spread I would get 0.27 credit (all related to Friday prices). If I use naked put on Feb 18, then I would select the 15P for 0.15 because of better DP – 1.15USD.

Yes, Weeklys offer a better return. But that should not surprise you. The less time in the life of any option, the more rapid the time decay and the greater the risk – if the stock moves toward and then through the strike. One month options offer a better return than longer term options. Thus, Weeklys offer a better return than ‘regular’ front-month options. This higher annualized reward does come with elevated risk, so it is not for everyone. Weeklys have become very popular quickly. Buyers like the cheap ‘action’ and sellers like the rapid time decay. If you are comfortable with holding these trades, then there’s nothing wrong with trading Weeklys. I know it’s a paper account, but if you treat it as if it were real, you will learn a lot about how comfortable you feel with those trades.

Do you think I’m picking only “penny/dimes” on this approach? Do I risk too much from your point of view?

No. If you want to trade Ford, only 1-point spreads are available and it is far more important to trade the stock you want to trade (F in this case) than to worry about other considerations. I believe you are making reasonable and effective trades. Just remember that your long-term results are going to depend on how well you manage risk. There is absolutely nothing wrong with selling a $1 spread for that 13 cents. I object to ‘picking up dimes’ by selling a 10-point spread for thirteen cents, but when it’s a one-point spread, that’s equal to collecting $1.30 for a 10-point spread. That’s fine.

Additional question related to it. Is it good to use weeklies on collar/covered call/cash secured put strategy (I’m using IB so commissions on trade are not that significant to overall trade price) – my thinking about weeklies is to address possible steady declining market which makes “proportionally” less move over week than over month?

‘is it good’ to use Weeklys (note the odd spelling)? It’s acceptable is you prefer to trade short-term options. There is nothing ‘bad’ about it. However there is higher risk (gamma explodes when the stock approaches the stock price). Too risky for me, but we each define our own comfort zones.



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Trade plan for the rookie

Trade Plans

I’ve posted about trade plans more than once. However, it’s an important topic and this time let’s discuss it from the perspective of a rookie trader.

It’s advantageous to write a trade plan for every trade and to keep that plan updated. As time passes or when the position changes (because of an adjustment) it’s time for another update. Why? The primary purpose is be certain that a trader understands why the trade was made. More importantly, the plan makes the trader think about situations when it’s no longer viable to hold the trade as it stands. The experienced trader will recognize the need for taking steps to reduce risk. The inexperienced trader may become frozen with fear or uncertainty. Having a trade plan that applies to the current situation offers one reasonable trading solution. The plan may be the decision to exit, reduce size, or make a specific trade to reduce risk. Having a solid trade idea in times of stress makes a huge difference to the confidence level required to pull the trigger on the trade suggested in the written plan.

Please recognize that it is not a winning strategy to enter into a trade just because it feels right – when you have no ‘real’ reason (other than your gut) for making the trade. [NOTE: If your gut has a good track record, then it’s right to pay attention to it.] If you are making a directional play, ask yourself whether you are truly bearish/bullish for a good reason. If it’s a non-directional play (such as an iron condor) does the reward justify taking the risk? If you have any reason to believe that a volatile market is approaching, then it is an inappropriate time for iron condors, writing covered calls, or other premium-selling strategies.

To decide if the risk vs. reward numbers for the trade are attractive, a trader must have both a profit target AND a maximum loss target (your own worst case scenario). Reminder: Just because a trade strategy comes with a built-in maximum loss, there is no reason to become lazy and allow the position to slowly reach that maximum. The plan must be realistic and based on having the discipline to take that loss – when the time comes.


Trade a 20-point iron condor by collecting $4.00 credit

The maximum gain is $400 and the maximum loss is $1,600. In reality, you would probably exit before $400 is earned. Thus, the profit potential is less than $400. It’s important to know (fairly closely) the real target.

I hope the maximum loss is less than $1,600. If it is, you must decide how long to carry this trade before exiting. By writing that number into your plan, you become aware of that number. For more experienced traders, the number may be flexible. If there is a good reason you can allow a slightly larger loss. However, the trap that must be avoided is deciding that the loss has become so large that you may as well gamble with the position. Long term success comes to traders who avoid the big losses.

As the trade progresses, you may want to make minor changes, but the experienced plan writer understands that it’s worthwhile to have a written plan – just in case action is needed when the market is volatile and you, as an inexperienced trader don’t know what to do. The answer is to do exactly as the plan describes. It may not be the best possible solution, but it is a well thought out plan, and is going to be a reasonable choice.

Why bother?

The negative side of plan writing must be mentioned:

  • It takes time
  • It requires thought
  • It’s not as much fun as making trades that feel right at the time
  • It takes discipline
  • You may not want to adhere to the plan when the time comes

The rookie plan writer

I understand completely. As a true beginner with no trading experience, making these plans is virtually impossible. How can you have any idea when it may become uncomfortable to own that specific position? How can you know how much profit to seek or at which level to limit losses?

The answer is: You cannot know. However, you can make a reasonable estimate. It takes trading experience to get a good feel. However, you can take a stab at it. Make a guess. Obviously when you are at this stage of your trading career, one of the things you are learning to do is to write a trade plan. Thus, it is clearly understood that the plan is not very valuable as a plan of action and that you may not trade as the plan directs.

Nevertheless, altering the plan to something better – assuming you have the time to do it – is a learning process in itself, and the next plan you write will be a better version. You not only learn to trade, but you also gain experience in writing plans. It won’t be long before those plans become valuable and truly assist in the decision-making process.

One good method for gaining experience is to write plans for trades in a paper-trading account. Think about it: It requires extra for each new trade, but the purpose of paper-trading is to learn something useful. If you not only gain trading experience, but also gather plan-making experience, it’s a double win. As always, there are no guarantees, but a successful plan writer has a better chance of succeeding when real money is at stake. And that’s the bottom line, isn’t it? Doing everything you can to recognize risk and avoid blowing up your account has to be a top priority. And that possibility is almost never given much thought by the overconfident rookie trader.

Keep the plan simple and only make it more detailed as you move ahead with your education. For your initial plan, include profit and loss targets. The next time try to estimate the stock price at which an adjustment may become necessary.

Clarification: When speaking of risk in this context, I almost always refer to the risk of mounting losses. However, when a position has been working well and profits have been accumulating, there is always the risk of losing those profits. That’s a true risk. One of the factors to consider is reducing trade size, exiting the trade, or adjusting to lock in some profits. Risk refers to any position that doesn’t feel right. If profits could easily vanish, that’s just as much of a risk as the chance that losses can suddenly increase. In either situation, it is your money at risk, and a good trade plan insures that the chances of losing that money are minimized.

That’s the rationale behind getting a lot of practice before entering the game with real money.

Paper trade. Open a practice account with your broker (or at an online site) and make some trades. Manage those trades. As you see more and more different situations (please take notes in a trade journal), you will begin to see things with your own eyes. I can tell you what to look for, but seeing for yourself is far better as a learning experience.

It’s all too easy for the rookie trader to assume that plans are too complicated or that they are for the more experienced trader. However, if you expect to become one of those experienced traders, becoming concerned with risk and writing trade plans go a long way toward keeping you in the game long enough to gather that experience.



Coming April 1, 2011. Options for Rookies Premium

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New option strategies?


I have two strategies that I use.  I'd like to run these by you for comment.


1.  A biased stock market offers opportunities in ratioed collars.  The stock market tends to drift or steadily move higher but can move lower with great speed.  It tends to go up over time more than it goes down.  How about long the index, short otm calls and long the more otm money puts maybe two to one the short calls so as to be premium neutral.

This idea is fine – to a point.  Most collar traders prefer to take in some cash, but if that's not a concern, it's not a problem.

When you trade as suggested, the puts tend to become worthless as time passes – and offer protection only against a real disaster.  With the 'normal' collar, the put offers better protection (higher strike price).  The rationale for adopting your strategy is the opportuity to own extra puts, thereby giving you the chance to earn a big profit on a severe decline.

From my perspetive, your idea is neither 'better' nor 'worse.'   It's making a choice: 
Do you prefer to own one put that is closer to the money – or two puts, farther OTM – at the same cost?  The former gives better protection most of the time.  The latter sacrifices that 'better protection' for an occasional jackpot.

I find that traders often don't take the time to look at their positions as equivalent to other positiions that are easier to understand.  You want to buy a collar.  But you also want to  embed a 2:1 put backspread.


You trade an index priced at 700 and decide to buy the 680P as part of a collar.  With an IV of 30 and 60 days to expiration, the 680 put costs ~$24.  To find a put priced at ~12, you would have to choose the 645P.  And I'm giving you the benefit of the doubt by assuming that there is no volatility skew and that you can pay the same IV for the 645P as for the 680P.  In reality, you would probably have to buy the 640 put to find one that costs only $12.

How do you feel about owning this position at even money?  I ask because you do own this position when you construct your collar wih two puts per call.

Long 2 Apr 645P

Short 1 Apr 680P

Underlying index is 700; Expiration is in 60 days

The true problem with this strategy is that traders tend to hold positions until the options expire.  With your plan, time is a real enemy and holding to the end is not a good idea.  Here's why:

 If the market really tanks or when IV surges, this spread is a winner – assuming it happens before too much time passes.  If the market moves steadily lower, your 680 put threatens to become a costly short while the 645s fade slowly into oblivion.

That's true of any back spread.  The point I am making is that unless you want to own black swan protection, these back spreads are tricky to manage.  And that is especially true when you are an individual investor paying retail commissions.

I don't like the back spread for practical considerations, although the risk graph is definitely pretty.  You may love it.  That's ok.  Please recognize that your suggested trade is merely tacking this backspread onto your standard collar.  I think you'd be better served if you looked at the total package that way, rather than as 'something special' that you devised. 

 The back spread looks great on any risk graph – when the position is new and there's lots of time before the options expire.  However, as time passes, it begins to look significantly worse.

My bottom line:  This idea is sound if you recognize that you own the backspread plus the collar and that this combination is the position you want to own.


2. How about collecting premium (call credit spreads) to finance a long put position? 

Owning futures (or stocks) can produce an account wipe-out on a big move lower.

Straight long options can kill with time decay.

But short an atm call spread and long an otm put solves both problems as long as commissions and the bid-ask in the options are not too bad.

This is simply one way to take a short position.  Being short the call spread instead of selling anything naked is an excellent way to limit risk.  That's important here because you own the put – a bearish position and are doubling up by selling the call spread.  There is something in your style that likes owning extra options and finding a way to pay for them by taking in cash from a secondary trade.

There is nothing wrong with this idea.  In fact, it's very similar to the 'risk reversal' strategy, in which the trader sells the call (not the spread) and buys the put.  The call sale finances the cost of the put.  I like your idea better becasue it involves buying an OTM put to protect the entire trade from resulting in a gigantic loss.

I find his to be a very reasonable bearish play (obviously this idea can be used for the corresponding bullish play).


No matter which underlying you trade, those wide bid/ask spreads that you mention can be a problem.  One hint:  You never know the true market until entering an order.  I always try to trade near the mid-point of those wide markets – recognizing that I must take the short end of the stick.  That means, paying a bit above the mid when buying and offering below the mid-point when selling.  If I cannot get a 'decent' fill, I find something else to trade.  Index options are actively traded and despite those horrible bid/ask spreads we see on our quote screeds, you should be able to get 'decent' fills when you enter spread orders.

Bottom line: These are reasonable ideas.  You gain something in exchange for something else.  That's always the difficult part about trading.  We want the best of all worlds with our strategy, but it's always a trade-off.  However, here is one compromise:  Do a 'regular' collar, collecting a cash credit.  Use that cash to buy some OTM puts.  You own far fewer puts, but you have better protection.  Just a thought.


The December 2010 issue of Expiring Monthly will be published today.

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Collars: Revisited

It's time to take a fresh look at collars.  In mid-2008, we wrote about collars and how they work.  As a reminder, a collar position consists of owning 100 shares of stock, one (almost always an out of the money) put option, and being short one out of the money call option.

The purpose of owning this position is to limit losses when the market falls.  The trade is slightly bullish and there is limited upside profit potential.

This is one option strategy that is preferred by those who want to protect their holdings from a devastating market decline.  It's very effective because losses are limited (the collar owner maintains the right to sell shares at the strike price of the put he/she owns).  There are two reasons that this type of portfolio insurance is so appealing:

  • It almost always costs no cash out of pocket to own the collar.  That's true when the investor collects as much cash when selling the call option as it costs to purchase the protective put option
  • This position provides both safety and the opportunity to earn a limited profit.  Investors who only buy puts must pay the heavy cost and have little chance to earn any money, unless there is a significant rally

Experienced option traders are probably aware that owning the collar is equivalent to two other positions, each of which is a popular strategy on its own.  However, many novice traders do not recognize that they may be trading collars in a different format:

  • Selling an OTM put spread
  • Buying an ITM call spread

Example (this is an example and NOT a recommendation) 

The Traditional collar:

Buy 100 shares of AAPL, paying $300 per share [$300 is not current price]

Buy one AAPL Dec 280 put

Sell one AAPL Dec 320 call

Sell the put spread – the equivalent position:

Buy one AAPL Dec 280 put

Sell one AAPL Dec 320 put

Buy the call spread – the equivalent position

Buy one AAPL Dec 280 call
Sell one AAPL Dec 320 call

For each of these three trades:

Maximum profit occurs when AAPL is above 300 at expiration
Maximum loss occurs when AAPL is below 280 at expiration

Profit and Loss are the same for each of the three positions when the options are priced efficiently.

So What?  Who cares?

I approve of collars.  I believe they are an appropriate strategy for protecting a portfolio.  However, I know that some people adopt strategies without understanding how they work.

The point that I want to make today is that the collar looks good – and is good for the appropriate investor/trader.  However, many people who adopt collars would never sell a put spread nor buy a call spread.  Yet, they are making the identical trade.  It's important to recognize what you are truly trading.

Some collar traders would be better served by adopting one of the alternative strategies.  The margin requirement is low and trading a position with two legs is far more cost efficient than trading one with three legs. I suggest that collar traders make an effort to trade the corresponding call or put spread in place of the collar.


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Protecting a Portfolio with Collars. How Many Puts are Required?

Previous post

1) I believe you agreed (with caveats) that a portfolio with a beta of .50 and desired maximum loss of 15% can purchase SPX puts 30% OTM (I ignored transaction costs). My confusion: how many contracts to buy.

Assuming I have a $1mm account with a beta of .50 and want to limit losses to 15%. Current S&P is $1,080; the one year 750 put is $36.90.

If I buy 5 at that price wouldn't my portfolio be insured? Say the S&P falls by 35%, the value of my stock & bond portfolio would be $825,000 (given the beta). I would have paid $18,450 for the puts (5*100*36.90) and when I exercise them at 700 I collect $25,000 ((750-700)*100*5).  That gives me a $6,550 gain on the options my portfolio a total value of $831,500 and a loss of a little over 16%.

I ran the numbers at higher loss levels and get the same results – the portfolio loss is limited to roughly 15% with five contracts.  This is troubling to me because your explanation makes sense, but my numbers are giving me the desired insurance.


2) With regard to "the long dated put does not provide the hedge you think", is this because of the following reasons: (1) If you pay up for IV when it is high and IV goes lower the put loses value? This is also why buying longer dated puts and selling shorter dated calls can be risky. (2) The delta is lower given the longer expiration date? (3) If the market moves up, your puts decrease in value and probably no longer provide the desired hedge? 


3) Assuming the above assumptions are correct, if the goal is pure insurance are those points negligible? I believe you outlined this in the post "Q & A. Stretched Collar (LEAPS Puts and Short-Term Calls)". That being said, if IV is high (say like now) then maybe shorter dated puts will prove more beneficial in the long-run.

Again, I want to thank you for your help and hope you can clarify those few questions/statements. 

Our firm is just trying to find a good way to manage risk and insure portfolios. Options seem like the best way (and I loathe structured notes). Thanks so much and keep up the good work. When we start introducing options to our clients your book will certainly be the go to we recommend.



1a) Yes.  SPX is a reasonable proxy for your diversified portfolio, if that portfolio consists primarily of large-cap stocks.  If not, other indexes may be more appropriate.

1b) Yes you can buy 30% OTM puts to suit your scenario of losing no more than 15% (of a 0.50 beta portfolio) in a bear market.  But, this is true only as long as  beta remains near 0.50.

1c) How did you decide to purchase 5 puts? When the strike price is 750, each put gives you the right to sell $75,000 worth of stock.  That equates to $375,000 – and you own a $1mm portfolio.

When buying puts to protect the portfolio, you must use the strike price to determine how much stock you will be able to sell, should it become necessary.  [That statement applies to American style options.  But the math hold true for European options, even though you do not actually sell any shares]  The current index price is not the answer.  Thus buying 5 puts does not give you the right to sell 5 * 1080 *100 worth of shares.

I don't know what you did when you ran the numbers at higher loss levels, but look at this:

If the market is cut in half when expiration arrives, then SPX is 540.  The puts are ITM by 210 points and are worth 21k each, or $105,000.  The portfolio declines by 25% and is worth $500,000. Addendum.  The portfolio is worth $750,000.  Mea culpa. Total value of your assets: $605,000. $855,000  Net loss: 40%. 15%

Assumption: net cost to buy puts and sell calls is essentially zero

Conclusion:  you are not buying enough puts.  Five puts appears to be the correct quantity.


Take it to the (impossible) extreme: SPX goes to zero.  The puts are worth $75,000 each.  How many puts must you own to have $850,000 cash? Five is not sufficient.

1d) You calculated the loss by ignoring the sale of call options, and that's not something to ignore.  Let's assume you collect as much from the calls as you pay for the puts.  That's going to be approximately true, unless you want to take a more bullish stance.


2) Regarding buying long-dated puts and selling short dated calls.  This is important.  I'm pleased that your results are troubling.  They should be. You seem to believe that once the market drops 35%, you no longer lose money on a further decline.

That's true only when you are adequately hedged.  And you believe 5 puts is the correct quantity to buy.  Read on.

a) When the market drops and the calls no longer offer much in the way of downside protection, your position is essentially: Long puts plus long stock.

That is equivalent to being long the long-dated call (same strike price as the put).  Please tell me you understand this – if not, you must pause in your questions and learn about equivalent positions (Chapter 15 in The Rookie's Guide to Options) before going further. 

Thus, you own that synthetic LEAPS call and when the market tanks, what do you expect will happen to the value of your call option?  It's positive delta and you have essentially zero hedge.  Sure, it will pick up a bit of value as IV increases, but the value of the call, and the value of the portfolio decreases.

That's the reason why collars are a slightly bullish play.  You earn a limited profit on the upside, but lose on the downside.  The purpose of a collar is to limit, not eliminate, those losses. When you own a call (or a synthetic call as you do in this scenario), loss is limited.  But make no mistake, you have a loss.

By selling the long dated call instead of the short-term call, you collect MUCH more premium.  You still lose on the downside, but the loss is less.  If the market punches through the put strike price (of your collar), then you have ultimate protection.  But you still lose (in your scenario, that's 15%).

b) If the market surges and moves through the call strike price, then the call delta moves quickly to 100 and the put delta moves slowly towards zero.  This is the reason why selling short-term options is so dangerous – high negative gamma.  The long-term options you buy have a much smaller gamma and the option delta does not approach 100 quickly.  The delta moves slowly. 

That means your put loses significant value on the upside while your covered call portion (yes: the long stock plus short call is a covered call) of the position gains, it gains much less quickly than the put loses.  Two reasons:  the put value gets crushed by an IV decrease and it contains far more time value  than remains in the call.

The profit potential of a covered call that has already moved significantly into the money is merely the time premium (not its full price) in the call.  And that is going to be far less than that of the long-term put.

Mixed month collars are risky and you do not want to trade them for clients who are using collars for safety.  Mixed month collars are NOT safe positions.


3) Yes.  In my opinion long-term options (when planning to hold for a long time) should only be purchased when you believe IV is relatively low. 

Yes, shorter-term puts are better when IV is high.  The definition of 'high' is highly subjective.  And short-term puts are FAR more effective when the market tanks?  Why?  They have a much higher positive gamma.  The delta moves to 100 quickly.  There is far less time premium to lose when they move deep into the money.

But the bottom line is that you do not want to own mixed month (stretched) collars.  Just too risky for you and your clients.  For aggressive clients, that's another story.  But clients who use collars for safety should not be subjected to this risk.

ZA: If your firm feels some consultation would be beneficial, my rates are truly a bargain, and you get to ask all the questions you feel like asking.  With immediate replies.


"I thoroughly enjoyed your book “The Rookies
Guide to Options”.  The book has paid for itself many times
over.  Thank you."  VR


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