Proper Position Size When Trading Collars

Mark,

You suggest not trading too many collars. However, in using your
insurance method of 2nd month OTM put credit spreads and front month
insurance, I noticed that the profit/loss charts are similar to
the ones in "Rookies" in the chapter on insurance. The insurance works!

If you have a number of spread contracts and use insurance to cover
them and are willing to risk a pre-estimated loss while expecting a
profit, would you still recommend only having a few contracts?

Thanks,

Greg

***

Hi Greg,

Good point.

I make the assumption that most individual investors who are new to options will not be interested in owning insurance.  The truth is, that it's not necessary to buy insurance when you own an appropriate (for you) number of collars.

Often, when writing about collars, I am trying to reach two audiences:  those who are regular visitors to Options for Rookies and those who found my writings elsewhere.

It is to that latter group that I am speaking when I issue the warning not to trade too much size.  It's easy to feel so safe with a collar position, and it's limited risk, that an investor can own more collars than prudence dictates.

The warning not to buy too many collars is easier to understand when you look at the equivalent sale of a put spread. The possibility of a loss (with a put spread) is more obvious to those who are unfamiliar with the concept of equivalent positions. I know you understand that there is a limit to how many of those you can afford to sell.

If you decide to own insurance (I assume it's downside insurance only) for collars, then yes, you can afford to trade more size.  As long as you recognize how much risk you are taking and remain within your comfort zone.

One further warning:  Collars allow for limited profits.  I know you 'expect' to earn a profit, but is that realistic?  Be certain that the cost of insurance does not eliminate all chance to earn money from the trade.  It's easier to buy insurance when the profit potential is sufficient to cover the cost of  that insurance – with enough left over to give you a high probability of earning a profit.

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