Overview
We have one week left until the collar strategy we entered on the Nasdaq 100 Trust (QQQQ) expires. We chose to use a real-world example using a mock trade on the Qs, given the large gains made in the Qs since last June. At the same time, the fear indices were at support and this was a reason for concern.
Remember, a collar is the purchase of a put to protect the downside of a stock or index. But we also sell a higher strike call to offset the cost of the put. The pros of this strategy are that we are protected if the underlying falls sharply, but can do so for little or no cost. The risk we take is that if the underlying rises sharply, we do not get to participate in the gains past a certain point.
Of course, we have seen a mild correction in the Qs with the fear indices jumping higher. As a result, the current status of our mock trade is showing a better return than if we had just held onto the Qs alone.
QQQQ Mock Trade
The collar we set up is on the Qs and we have seen a correction in stock prices. After hitting a low of $42.15 last Monday, but has since recovered some. Below is the data for this trade for the week's we have been discussing it.
Jan. 25, 2007
Bought 500 shares QQQQ @ 36.03
QQQQ @ 43.73
Current Profit = $3,850 (43.73 â 36.03) x 500
Buy 5 March 43 puts @ 0.75
Sell 5 March 45 calls @ 0.65
Total debit = $50 (0.75 â 0.65) x 500
Max profit = $4,435
Min. profit = $3,435
Feb. 8, 2007
Bought 500 shares QQQQ @ 36.03
QQQQ @ 44.45
Profit in Shares Before Collar = $3,850 (43.73 â 36.03) x 500
5 March 43 puts @ 0.30 (bid)
5 March 45 calls @ 0.75 (ask)
Collar debit = $50 (0.75 â 0.65) x 500
Total debit for collar and stock = $18,065.00
Current Profit = $3,945.00
Max profit = $4,435
Min. profit = $3,435
Feb. 20, 2007
Bought 500 shares QQQQ @ 36.03
QQQQ @ 44.68
Profit in Shares Before Collar = $3,850 (43.73 â 36.03) x 500
5 March 43 puts @ 0.15 (bid)
5 March 45 calls @ 0.80 (ask)
Collar debit = $50 (0.75 â 0.65) x 500
Total debit for collar and stock = $18,065.00
Current Profit = $3,950.00
Max profit = $4,435
Min. profit = $3,435
March 1, 2007
QQQQ @ 43.13
Profit in Shares before Collar = $3,850 (43.73 â 36.03) x 500
5 March 43 puts @ 0.66 (bid)
5 March 45 calls @ 0.15 (ask)
Collar debit = $50 (0.75 â 0.65) x 500
Total debit for collar and stock = $18,065.00
Current Profit = $3,775.00
Max profit = $4,435
Min. profit = $3,435
Mar. 8, 2007
QQQQ @ 42.97
Profit in Shares before Collar = $3,470 (42.97 â 36.03) x 500
5 March 43 puts @ 0.51 (bid)
5 March 45 calls @ 0.03 (ask)
Collar debit = $50 (0.75 â 0.65) x 500
Total debit for collar and stock = $18,065.00
Current Profit = $3,660.00
Max profit = $4,435
Min. profit = $3,435
Figure 1: Risk Graph of Mock Collar Trade on Qs
Our current profit sits at $3,660 when we include the collar. This is about $190 higher than if we had just held onto the Qs alone. Remember, a collar is normally used as no cost insurance and we aren't trying to make large gains. However, it is nice to know that despite a loss in the Qs, we have made some extra profits.
Conclusion
There are few things that a trader needs to decide at this point. First, are you still worried about further declines in the Qs or do you think the worst is over? If the latter, then you can hold on for another week until expiration or roll out to an April collar. If you are no longer worried about further declines, you could close out the collar at anytime and just hold onto the security. We will follow this trade for one more week and next week we will show how rolling forward would work. In the meantime, if you would like me to cover any specific questions, please ask them on my forum.
To read previous installments of Real-World Trading, please click here.
Jody Osborne
Senior Writer & Options Strategist
Optionetics.com ~ Your Options Education Site
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