Trading With Collars

  • If you’re truly a trader you should be elated by the opportunities the current extreme economic fundamentals & price aberrations bring with them, the more extreme the greater potential.
  • We all know stocks are high.
  • No one really knows if we’ll see +0.00% or another +50.00% out of this market prior to reversal into a bear market.
  • As a trader should you care if you make your money in long or short positions? Or what market you make it in?
  • 2016 extreme economic fundamentals, record price action and market price aberrations have generated greater opportunity than any other period I’ve seen in my 20+ years as a professional trader.

Since 2010 what do you think has been more profitable?

A) Trying to call the top of this market

B) Trading with the long term price momentum already in place

Over the next decade what do you think would be the most productive use of your time and energy to achieve the goal of profitability?

A) Trying to weed through countless articles and charts to justify being a perma-bull.

B) Trying to be the first person to call the top of the market prior to the major reversal into a bear market.

C) The development and implementation of defined risk trading strategies that will enable you to capture major market moves with the established momentum of the market, up or down that we’ll see over the next decade.

Let’s skip all the fundamental rhetoric and focus on price action using one of the most liquid contracts on the board.

S&P 500 contract specifications

Each 0.25 change in price = $12.50

Current margin requirement = $4,200

Current contract value at 2,109 = $105,450

Looking at the daily chart below if you are trading with market momentum (green line) what should your current position be, long, short or neutral?

Price action is still above the moving average (green line), support has not been violated and the overall trend is still higher.

On the weekly chart, long, short or neutral?

Price action is still above the moving average, support has not been violated and the overall trend is still higher.

Monthly, long, short or neutral?

Price action is still above the moving average, the market is currently above support and the overall trend although getting tired is still higher.

Using these simple indicators and properly structuring defined risk trades I have been long the S&P 500 for the majority of the time between 2010 and 2016.

On days like last Friday, or potentially the downward moves we’ll see this week, I should be uncomfortable being long the S&P, I’m not and it’s solely because of the way I structure my trades.

On deck this week

The way my positions are laid down I don’t care if the S&P 500 drops to zero today. My risk on my current trade has been defined since I established it 15 June 2016.

On the trades for this sector of my US portfolio I have zero chance of being stopped out, stressed out or scared out of the market. Most importantly, I’ve done this without wasting precious investment capital on option time premium to hedge my risk.

Setting up the trade

If you had no fear of the violations we’ve seen to support and you’re trading with the overall market momentum (red line) should you be long, short or neutral this market?

On weekly chart, long, short or neutral?

On the monthly chart, long, short or neutral?

My position

A) Entry date, June 15th 2016, futures entry price, 2,071.75, contract value $103,575, I allocated $21,000 per position.

When a establish my position I instruct the desk to collar the 2,071.75 futures position to define my risk on the trade and for the duration of the trading period.

Collar

B) Sell the 2,121.00 September call collecting option time premium

C) Purchase the 2,021 put using the collected 2,121.00 call premium.

Net time premium paid/collected on the collar to hedge this position from 15 June 2016 to 16 September 2016 = -$287.50

If your desk is on their game they should be able to execute the futures position and options writes simultaneously on one order, trying to do it on your own online is a waste of time and you’ll generally lose more getting the order off than the desk fee costs to have a capable desk do it for you.

Potential outcomes for this trade

The market stays the same, net loss “all in”, -$437.50

-$287.50 in option time premium paid out for the collar (sold the 2,121 September call, purchased the 2,021 September put).

-$0.00 on the futures position, entry at 2,071.75 offset at 2,071.75.

-$150.00 (maximum) for all bid/ask spreads, brokerage, exchange and regulatory fees.

Loss on my $21,000 allocation -2.08%

The S&P goes to zero, net loss “all in”, -$2,975

-$287.50 in option time premium paid out for the collar

-$103,587.50 on my 2,071.75 futures position

+$101,050.00 on the purchased 2,021 put.

-$150.00 (maximum) for all bid/ask spreads, brokerage, exchange and regulatory fees.

Loss on my $21,000 allocation -14.17%

In order for me to lose my $21,000 deposit per position I’d have to be 100% wrong calling the overall direction of the market for 21 months in a row.

The S&P goes to 2,130.00, net profit “all in”, +$2,462.50

-$287.50 in option time premium paid out for the collar

+$2,462.50 on my 2,071.75 futures position, this position is called away from me at 2,121 (the call I sold)

-$150.00 (maximum) for all bid/ask spreads, brokerage, exchange and regulatory fees.

Net gain on my $21,000 allocation +11.73% for the 3 month period.

Trading with collars

Risk is defined on the trade and for the duration of the trading period without wasting precious investment capital on option time premium to hedge. In the example above I spent $287.50 to hedge a position worth $103,587.50 for 3 months.

You can’t be stopped out of your position, if the overall trend continues your trade will be profitable.

The only way your position can be called away from you is at a profit.

If your call it’s it blow out of the trade on or before delivery.

Common sense

What do you think is the best strategy when trading a market that’s been in a 6 year uptrend, considered tired and experiencing hard sell offs as it tries to catch its breath before attempting a higher high?

A) Establishing or maintaining a long position with the trend, no stop loss orders where your theoretical risk is the entire value of the position.

B) Establishing or maintaining a long position with the trend using stop loss orders that may be hit 1 to 4 times prior to your profit objective being achieved.

C) Buying net option time premium to try and capture the trend, option time premium that is efficiently priced by professional options traders where the probability of loss is greater than gain on every trade.

D) Entering or maintaining a trade with the major trend up or down where your risk is defined on the trade and for the duration of the trading period, your only concern, calling the overall market trend correctly (collar)

Why collar positions?

Ask yourself if you could handle a move like 1987 -39.26 in 2 days?

When we eventually enter a bear market like 2,000 through 2002 do you think you would make more money trading with the trend short or trying to buy the dips and sell them higher against the major trend?

2000-2002 -52.27% for longs, +52.27% for shorts

Or the same bear market scenario from 2007 to 2009, what side of the market do you think would have been less stressful to trade and generated superior gains, long or short?

2007-2009 -60.15% for longs +60.15% for shorts

Millions have been made for those willing to short and turned many a perma bull into a steer.

This same strategy can be implemented in any high volume that has decent liquidity in the underlying options.

  • Apple (NASDAQ:(AAPL)
  • Microsoft (NASDAQ:MSFT)
  • Bank of America (NYSE:BAC)
  • Alphabet ([[GOOG]], [[GOOGL]])
  • Pfizer (NYSE:PFE)
  • Cisco (NASDAQ:CSCO)
  • Goldman Sachs (NYSE:GS)
  • Moody’s (NYSE:MCO)
  • Oracle (NYSE:ORCL)
  • AT&T (NYSE:T)
  • AbbVie (NYSE:ABBV)
  • JPMorgan Chase (NYSE:JPM)
  • Baxter International, Inc. (NYSE:BAX)
  • General Electric Company (GE)
  • SPDR S&P 500 Trust ETF (SPY)
  • SPDR Dow Jones Industrial Average ETF (DIA)
  • iShares MSCI Emerging Markets ETF (EEM)
  • SPDR S&P Metals and Mining ETF (XME)
  • SPDR Gold Trust ETF (GLD)
  • iPath S&P 500 VIX Short-Term Futures ETN (VXX)
  • Market Vectors Gold Miners ETF (GDX)
  • Ford Motor Company (F)
  • Financial Select Sector SPDR ETF (XLF)
  • iShares China Large-Cap ETF (FXI)
  • Shares Russell 2000 ETF (IWM)
  • COMEX Gold Trust (IAU)
  • Physical Swiss Gold Shares (SGOL)
  • DB Gold Fund (DGL)
  • DB Gold Double Long ETN (DGP)
  • UltraShort Gold (GLL)
  • Gold Trust (OUNZ)
  • Ultra Gold (UGL)
  • DB Gold Double Short ETN (DZZ)
  • 3x Long Gold ETN (UGLD)
  • DB Gold Short ETN (DGZ)
  • 3x Inverse Gold ETN (DGLD)
  • Gartman Gold/Yen ETF (GYEN)
  • Gartman Gold/Euro ETF (GEUR)
  • E-TRACS UBS Bloomberg CMCI Gold ETN (UBG)
  • X-Links Gold Shares Covered Call ETN (GLDI)

Any derivative

Finally, given current economic fundamentals and a pending rate hike, portfolio diversification shouldn’t be a dirty word.

Example

Ask yourself what is the single greatest fundamental threat to the overall stock market?

Maybe rate hikes?

Let’s compare trading interest rates higher to stocks higher from current levels.

What do you think has a greater probability of generating of a gain in position value of 50% by December 2019?

The S&P 500 moving from 2,110 to 3,165 or +50%

Expectations for 3 month deposit rates moving from where they are currently trading at 1.50% back to where they traded in December 2015 for an appreciation in contract value of 50%.

Rate contract price valuation chart

A) Current expectations for 3 month rates by December 2019

B) The move that would be required for the December 2019 contract to appreciate by 50%

C) Fed expectations for 3 months rates a rate they intimately set.

See this Seeking Alpha Article for how these trades work, 3 of my current positions and links to monitor these positions through December 2019.

Contact us with your questions and we’ll provide you an objective opinion, trading solutions, links for additional information and/or verification.

Regards,
Peter Knight

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RISK DISCLOSURE STATEMENT

PROGRAM AVAILABILITY IS DEPENDENT ON YOUR COUNTRY OF RESIDENCY AND FINANCIAL STATUS.

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE. THE RISK OF LOSS IN TRADING CASH MARKET, FOREX OR FUTURES CONTRACTS OR OPTIONS CAN BE SUBSTANTIAL, AND THEREFORE INVESTORS SHOULD UNDERSTAND THE RISKS INVOLVED IN TAKING POSITIONS AND MUST ASSUME RESPONSIBILITY FOR THE RISKS ASSOCIATED WITH SUCH INVESTMENTS AND FOR THEIR RESULTS.

BID/ASK SPREADS, BROKERAGE COMMISSION, CLEARING, EXCHANGE AND REGULATORY FEES WILL HAVE AN ADVERSE IMPACT ON THE NET OVERALL PERFORMANCE OF YOUR ACCOUNT. PRIOR TO MAKING A DECISION TO PARTICIPATE IN ANY INVESTMENT MAKE SURE YOU FULLY UNDERSTAND THE FEES ASSOCIATED WITH TRADING.

EXAMPLES OF HISTORIC PRICE MOVES OR EXTREME MARKET CONDITIONS ARE NOT MEANT TO IMPLY THAT SUCH MOVES OR CONDITIONS ARE COMMON OCCURRENCES OR ARE LIKELY TO OCCUR.

HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM. ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT.

IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADE PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF THE HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS.

YOU SHOULD CAREFULLY CONSIDER WHETHER SUCH TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR CIRCUMSTANCES AND FINANCIAL RESOURCES.

THE INFORMATION PROVIDED IN THIS REPORT CONTAINS RESEARCH, MARKET COMMENTARY AND TRADE RECOMMENDATIONS. YOU MAY BE SOLICITED FOR AN ACCOUNT BY ONE OF OUR REPRESENTATIVES OR EMPLOYEES. IT SHOULD BE KNOWN THAT THE REPRESENTATIVES OF OUR FIRM MAY TRADE FUTURES AND OPTIONS FOR THEIR OWN ACCOUNTS OR THOSE OF OTHERS. DUE TO VARIOUS FACTORS (SUCH AS MARGIN REQUIREMENTS, RISK FACTORS, TRADING OBJECTIVES, TRADING INSTRUCTIONS, TRADING STRATEGIES, AND OTHER FACTORS) SUCH TRADING MAY RESULT IN THE LIQUIDATION OR INITIATION OF FUTURES OR OPTIONS POSITIONS THAT DIFFER FROM THE OPINIONS AND RECOMMENDATIONS FOUND IN THIS REPORT.

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Asset Investment Management

Family Office, Advisors

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