Overwriting a Collar

Hi Mark,

I have been reading this blog for a while and decided to ask a question.

I have been out of option trading for a while and have decide to come back to
it. You have been mentioning that today it's really important to hedge risk and
I totally agree; that's one reason I've been out; I hadn't really figured out a
comfortable way for me to do that.

One strategy I have been considering, and now
testing in my paper desk, is to sell covered calls for premium, and delta balance
the buy/write – and then hedge that buy/write with with a long ATM put 6 or 7
months out. My thoughts are that the put will protect me against big opening
gaps while costing me less theta than the premium earned by the short call.

Any thoughts?



Welcome.  Glad you've taken the time to post a question.

The overall concept is sound.

You are really talking about a collar and not a covered call – if you buy the put.

There are modifications to consider.

1) I agree that hedging is a solid idea, and it's important.

2) Overwriting, or selling more than one call per 100 shares of stock does balance the deltas, but introduces upside risk that is not normally part of a covered call strategy.  I'm NOT suggesting that you avoid this play.  I'm only emphasizing it to be certain you are aware.

Unless you sell very low delta calls (I don't recommend that strategy), you won't be selling many extra calls.  And if you add the negative delta from buying puts, there will not be room to remain delta neutral and sell extra puts.

3) All by itself, buying puts adds a double safety feature: protected downside and (because fewer calls are sold) an upside that's not as bad.

4) The longer-term put is a big issue.

Yes, less rapid time decay is important, but it's not the whole story.

Yes, the longer term option has been shown to do better than one month puts, but data supporting that idea is limited.

Be aware that these puts are loaded with vega (that means their price is very sensitive to a change implied volatility).  In my opinion, you cannot buy longer term options, ignoring how much they cost.  When IV is high, you may be better off with one-month puts.  When it's elevated, perhaps 3-month puts would be a good compromise.  I'd own the 6-month put when IV feels 'reasonable' and the option price is not prohibitive. 

There is some judgment if you adopt this idea.  Obviously, if you always buy the longer-term puts, there's less judgment, and there is nothing wrong with that.  It depends on your preference.

5) I want to make one more point about the puts.  If you are truly buying them ONLY to protect you against large opening gaps, then near-term, OTM, not too expensive puts should be good enough.  Lots of bang for the buck.

But if you want to own puts for true downside protection – gap or no gap, that's a different story and your idea is sound.

I like collars.  The profit potential may not be too large, but being protected from big losses is far more important.  At least to me.


8 Responses to Overwriting a Collar

  1. Bob S 11/07/2009 at 8:25 AM #

    Can we see this illustrated?

  2. Mark Wolfinger 11/07/2009 at 8:45 AM #

    It’s difficlt for me to illutrate someone else’s strategy. So much depends on the strike prices chosen.
    If your broker offers risk graphs, take this position and plot it:
    Buy 10,000 shares
    Buy 100 puts with a 40 delta
    Sell 150 calls with 40 delta
    That’s a delta neutral overwritten collar. The upside will not be pretty, but the downside will look better.
    This is equivalent to:
    Buy 100 calls (delta 60)
    Sell 150 calls(delta 40)
    (Is this position you would be comfortable owning?)
    My plotting software is not available from my broker on Saturdays. I’ll try to do it tomorrow. But this should be easy for you to do for yourself.

  3. rluser 11/07/2009 at 10:41 PM #

    You can now log into TWS on Saturday. I don’t know if the plotting software works: I find it useless.

  4. Mark Wolfinger 11/08/2009 at 10:52 AM #

    I’m surprised there was no notice given about Saturdays.
    The software is not very good, but for me it’s a notch above worthless. And it does allow me to draw graphs for the risk profile of a specific position – even though the parameters cannot be changed.
    Thanks for the info.

  5. terry@terryorourke.com 11/18/2009 at 5:41 PM #

    Thanks for commenting on this subject.
    I get the vega problems with this trade because in my paper accound I had this trade on with HD this week and saw the results.
    BTW paper trading is really the way to go when testing one’s tolarance for risk!
    This type of trade requires some really large positions to pay off and given the volitility of the “system” today I am not comfortable with that.
    So, can you suggest a good way to sell theta while keeping risk under control?
    I have been working on selling puts and delta hedging with short stock to reduce commisions rather than covered calls because there are fewer trades involved.
    Thanks ,

  6. Mark Wolfinger 11/18/2009 at 9:01 PM #

    Paper trading is valuable, in my opinion. But some people cannot feel the fear when something terrible is happening, when cash is not real. I’m glad the paper trade works for you.
    When you sell theta, you take risk. It comes with negative gamma and negative vega. You can find complex positions that make Greeks look better, but you don’t want to trade complex positions.
    Best advice: Trade proper size for your comfort zone. It may feel foolish to trade very few contracts, but ‘size’ is the easiest and best way to manage risk.
    If you don’t like that, then own protection. Consider the kite spread .
    Whatever you do, it will reduce that theta.
    Selling puts and hedging with stock is exactly equivaent to buying straddles, with unequal number of puts and call. This is lots of gamma, but very negative theta.

  7. terry@terryorourke.com 11/25/2009 at 9:19 PM #

    Hi mark,
    I have been working my paper trades and am learning great stuff. I presently use TWS from Interactive Brokers and was wondering if there are other sites that I might consider. What I like about TWS is just how the platform is designed for working with the greeks. I particularly like the “hedge” feature in the “risk managment” page. It allows one to place a delta hedge on your complete portfolio with one button. It doesn’t execute the trades for you but the fields are all populated with the correct trades and aproximate amounts. Great for visualizing your delta position at a glance and what approaite trades to make. The “risk managment” page is really great not only as an educational tool but it really saves time in calculating all the greeks. I do this all by hand too just to dive into it and get a feeling for how they interact but that feature automaticly does it all which helps when one gets confused.
    I wonder if there are other trading sites that have such a wonderful platform. I have tried OptinsXpress and find it not quite as robust and “greek” friendly.

  8. Mark Wolfinger 11/25/2009 at 10:41 PM #

    Experienced option traders rate thinkorswim as offering analytical software that is far and beyond anything else out there.
    I took a quick look one time, and was impressed. But it does have a learning curve that may or may not be daunting. You must give it an evaluation.
    I’m fairly confident you will find it worth your time and effort. I also use IB.