Managing a Collar Position in a Declining Market

I received an important question from a long-time reader.  There are several important lessons embedded within this question:


I am long SPY at about 121.50 and protected by long September 120 puts. I sold June 122 calls against the position to defray the cost of the long puts (which, I believe, is something you advocate). I plan on selling additional calls in July and August to further reduce the cost. However, as SPY drops, the premium on the 122 and 121 calls is diminishing to almost useless levels. If I were to sell a lower call with a higher premium, like a 115 or thereabout, I risk a reversal in the market.

How do you suggest handling this set of circumstances?



Thanks for this very interesting question.  This discussion allows me to cover more than one of my favorite 'philosophy of trading' scenarios.

1) You own a SPY Sep DITM put (SPY is currently 108) plus stock.  You don't state how many puts you own, so I am going to assume you own one put for each 100 shares.

That means your true (equivalent position) is long SPY Sep 120 calls. 

2) Obviously this is a position that is delta long and does not fare well when SPY declines.

3) Here's
the very first thing you should do. ADDENDUM: Tuesday morning.  Markets are even lower.  Rolling the put is still right, but it's even more difficult to choose which call to write now.  IV will give you a better premium, but which strike?  You do not need to hold a $15 put
to protect stock.  Sell that expensive put and replace it with another

If you prefer to remain long vega, buy a Sep put with a lower
strike price.  How much lower?  I cannot tell you, but you want to get
some cash out of this position.  There are two ways to do that.  The
first is to roll down the put, as suggested here.
use some of that cash to buy an extra put or two
  The second is to sell
a new call option.

Note that if you sell the 120 puts and buy 110
puts, then your position will be long the (synthetic) Sep 110 calls. 
You will no longer fear a rally.

4) You are short Jun 122 calls.  These may have been ATM calls when you made the trade, but they have been offering almost no downside protection for the last several points that SPY declined.  

For all intents and purposes you are naked long Sep 120 calls.

5) I am in favor of selling calls when you own stock and puts, but when the put is 12 points ITM and the call is trading near zero, that's not a hedge and is not something I advocate.

Nor do I like the idea of owning long-term puts and writing short-term calls when trading collars.  These can be spectacularly successful, but are far too risky for me.  They may be okay for you – as long as you understand the extra risk inherent in these stretched collars.

There are almost 4 weeks remaining until the Jun options expire.  The Jun 122 calls last traded at 4 cents.  I can understand not wanting to waste money, but there is absolutely nothing to gain by waiting almost 4 weeks for these options to expire.  You are naked long the Sep 120 calls and unless you want to own that position, you should be doing something.  In fact, it's rather late.  But better late than never. Bid something to buy those options.  That frees you to sell other call options and complete the collar.

to be continued


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3 Responses to Managing a Collar Position in a Declining Market

  1. Brendan 05/25/2010 at 10:01 PM #

    Looking forward to more on this topic, Mark (and thanks)!

  2. John 05/25/2010 at 10:05 PM #

    Hi Mark,
    Recently I have been seeing a lot of the classical pump and dump scheme in RUT. The futures usually went much lower compared to previous day’s close, then RUT opens by gapping down, and then rising back up again, usually to previous level. And all these happens with a lot of rhetorical delusions on the news, like ‘futures down on euro woes’, ‘stocks up amid whatever nonsense’.
    So my question is, do you see this as a concern? My opinion is ‘I do’. I think the zig-zag behaviour is hurting people with stop losses. That means the guys with proper risk management will be toasted. On the side note, do you believe this is the undoing of plunge protection team?

  3. Mark Wolfinger 05/25/2010 at 11:54 PM #

    I’d like to save this reply for a separate post (Thursday).
    a) Plunge Protection has not been proven to me. I am agnostic
    b) P&D on RUT? I have doubts.
    c) The markets are not save for individual traders
    Thanks for comment/question