Tag Archives | stretched collars

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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