Option Strategies, Collars and Ladders.

I was thinking about the maximum loss with spreads and that I need to monitor them, loosely, to be sure they do not go negative on me. Particularly the current 116-118 bear call spread seeing as SPY (the S&P 500) is climbing smartly into the new year.

If I let a 10 contract $2 spread trade go and it hits the bought call price I will lose close to $2000. If it passes the bought call there are no further losses as the trades cancel each other out at that maximum loss at expiration as they exercise and the long call covers the short call.

I got thinking about a method to fix this trade by adding another option to it should it look like it is going to start losing. Buying another set of call contracts will allow the entire trade to profit if the price continues up.

So the trade would be this:

Sell 116 calls
Buy 118 calls
Buy 120 calls

This creates a maximum loss point at the 118 strike. Ideally I would want a longer term trade to allow some intrinsic value to be left in the calls near expiry if the price was heading up...close the trade one month out. Should the price take off I might choose to close part of the trade by buying back the short 116 calls or tying them to the 120 long calls and let the better priced ITM 118 ride.

If the price headed down I make whatever credit was gained from the 116-118 spread less the cost of the cheap 120 call by just letting the trade expire.

Checking in my options book I find that this is called a bear call ladder and my idea is very close except that this is a longer term trade that is best setup completely together...but my idea of a fix is also workable, it just costs more to execute later.

The other one that I found in the book was the collar. I thought I knew what a collar was, or I had one version of it in mind. The collar is a long stock position with a covered call sold for premium gain and a long put bought for protection.

Profits are gained when the stock price plummets and the put becomes valuable due to being ITM and some extrinsic value is added due to volatility, the sold call premiums are kept as well adding to the profits. The stock is a loss but can be kept after expiration in order to resell calls and repurchase puts if desired.

Profits are also gained if the stock climbs to or past the call strike. The upside is capped at this point as the profit is the difference between the original stock price and the call strike, plus the call premium from the sale less the cost of the put that expires worthless.

Again, upside and downside profits. The best part about the collar is that it can be made to be a guaranteed profit or very small loss if the right options are traded for the stock.

The worst part is it is a longer term trade 6 months and up and the cost of the stock must be carried the whole time. Having said that, using a dividend paying stock can add more profits and this strategy can be used in a TFSA as it is really just a covered call and a long put.

I now know what I am likely to do with that account now...or perhaps the RRSP as it has an added advantage of US dividends not subject to the US with holding tax.

Jeff.