Defining risk on every trade and for the duration of every trading period 

If you have questions send us a message, or schedule an online, using these links we’ll walk you through trade procedure enabling you to duplicate our trades or experiment with your own.

1) How this program controls risk by “collaring” every trade

  • A collar defines risk on the trade and for the duration of the trading period
  • Collars eliminate any possibility of the position being stopped out.
  • Because trade risk is objectively defined the margin requirement on the majority of trades is reduced.
  • Properly set up a collar is premium neutral (they don’t waste money on net purchases of option time premium to define risk)

2) Procedure for collared long positions 

15 September 2017 using procedure reviewed in Defining Trend, weekly price action is above the Exponential Moving Average 9 (red line on the chart below).

Generating a medium-term buy at 2,500.

2.1) The overall average linked here  was a 96% buy confirming the EMA9 defined trend.

2.2) The medium-term indicators linked here were a 100% buy confirming the EMA9 defined trend.

2.4) The EMA9, overall average and medium-term indicators all agreed.

Medium-term trades were permitted with the trend with a trade duration  11 to 29 days.

On the 15th of September 2017 we buy 1 S&P futures contract at 2,500.00 contract value $125,000.00. The margin requirement  is the Exchange minimum currently $5,050.00 or the maximum risk on the trade whichever is less. In this example the maximum risk on this trade is -$2,759.78 which is required margin to establish and maintain this position. 

Establish a long position at 2,500.00

2.5) To simplify determining the profit objective in this example I’m using the angle of the trend setting the objective at 2,550.00.  We’re anticipating the trend will continue and the 2,550.00 profit objective will be achieved on or before the 13th of October 2017.

Set the profit objective at 2,550.00

(This program uses support and resistance, volatilityimplied volatility and ranges  to make profit objectives more precise, to learn specifics  schedule an online review.

3) Setting up a Collar on a long position

3.1) We write a call against our 2,500.00 long collecting option premium

15 September 2017
Long futures at 2,500 (contract $125,000.00)
We write a call at 2,550.00 collecting 15.00 points = +$750.00.
Options expiration, 13th of October 2017
Contract value at 2,550.00 = $127,500
The only way our 2,500.00 long can be called away from us is at our profit objective of 2,550.00 generating a gain on the futures position of $2,500.00

Write the call at the objective of 2,550.00

3.2) Using the 15.00 points collected $750.00 from the sale of the call we buy a 2,450.00 put, cost 17.00 points = ($850.00).

The put objectively defines risk on the 2,500.00 long position for the duration of the trading period (13 October 2017 expiration)

The put also negates any possibility of being stopped out of the position.

Collected on the 2,550.00 call write = 15.00 points at our profit objective
Paid out on the 2,450.00 put -17.00 points to objectively define risk

Net cost of the hedge 2.00 points or $100.00,  which defines risk on a contract worth $125,000 from 14 September 2015 until 13 October 2017. 

Buy the put to define risk at 2,450.00

4) Potential outcomes for this trade

4.1) The market stays the same and settles on the 13th of October 2017 at 2,500.00

The call we wrote at 2,550 expires worthless, +15.00 points = +$750.00

The 2,500.00 long futures settles unchanged at 2,500.00 = $0.00

The 2,450 put purchased expires worthless, we lose 17.00 points = -$850.00

Total bid/ask spreads, commission, exchange & regulatory fees =-$159.78

All in net profit or loss = -$259.78

4.2) The market moves hard against us

The market drops from our entry price of 2,500.00 (contract value = $125,00.00) down 600.00 points -24.00% to 1,900.00 contract value $95,000 in “fast market action”.

During a “fast market” it is difficult if not impossible to liquidate a position. When the market moves far enough, trading is suspended and the market is “locked limit” (for today’s price limits see this link)

If a percentage drop like this did occur, it would have no impact on the maximum risk of a collared position because we own the put.

The put objectively defines risk on the 2,500.000 long for the duration of the trading period.

The maximum risk (in this example) is the distance between our entry at 2,500.00 contract value $125,000.00 to where the put we own engages at 2,450.00 contract value $122,250.00 = $2,500.00 regardless if this market moved to zero.

Loss on the 2,500.00 long futures position (600.00) points = -$30,000.00

The call we wrote at 2,550.00 expires worthless +15.00 points =+$750.00

The put we own at 2,450.00 is profitable 533.00 points =+$26,650.00

Total bid/ask spreads, commission, exchange & regulatory fees =-$159.78

All in net loss = -$2,759.78 on a market drop of  24.00% in fast market action.

A $100.00 hedge prevented a potential loss on this position of $30,000.

4.3) The market moves higher

The established trend continues to grind higher and the contract moves from our entry on the 15th September 2017 at 2,500.00, contract value $125,000 to our profit objective of 2,550.00 contract value $127,500 on or before the 13th of October 2017.

Gain on the 2,500.00 long futures position 50.00 points = +$2,500.00

The call we wrote at 2,550.00 is offset by the futures, we keep the 15.00 points in premium =+$750.00

The put we owned at 2,450.00 expires worthless -17.00 points =-$850.00

Total bid/ask spreads, commission, exchange & regulatory fees =-$159.78

All in net profit or loss = $2,240.22.

We can lay down another position at anytime placing a “3 way”. An example of a 3 way ticket,  buy an S&P, plus, minus 50.00 at a net cost of +2.00 for 3rd Friday expiration.

Translated you’re long a futures contract. We’ve written a call 50.00 points above the futures fill price. Using the collected premium bought a put 50.00 points below the futures fill price. We paid 2.00 points in option time premium (2.00 X $50.00 = $100.00) to a hedge our futures position through the  3rd Friday of the month.

5) Procedure for short positions

5.1) In this example I’m using  daily price action for a trade duration between 2 and 10 days. During the trading session on the 1st of  February 2018 price action moved below the  EMA9 for the 3rd day.

Below the EMA9, trend is down = short

5.2) The overall average  of the 12 indicators was a 24% sell, this confirms the trend defined by the EMA9.

5.3) The short-term indicators were a 60% sell, agreeing with the EMA9 and overall average of 24% of the 12 technical indicators.

5.4) All agreed, short-term trades were permitted with the trend using a trade duration between 2 to 10 days.

5.5) On the 1st February 2018 we sold 1  S&P futures contract (ESH18) for March 2018 delivery at 2,815.00 contract value $140,750.00.

Enter a short position at 2,815.00

5.6) Using the angle of the trend we set the profit objective at 2,740.00, contract value $137.000.00

We were anticipating the 2,740.00 profit objective to be achieved on or before the 9th of February 2018.

(This program uses support and resistance, volatilityimplied volatility and ranges   to make profit objectives more precise, to learn more schedule an online review.

5.7) We write a put against our 2,815.00 short position at the profit objective

Were 2,815 short futures at 2,815.00
Contract value = $140,750.00
We write a put against the 2,815.00 short at the profit objective of 2,740.00
Contract value $137,400.00.
In this example we’re using an expiration on the 9th of February 2018.

When you write (sell) an option you’re collecting option time premium,
On this put write we’ve collected 27.00 points = +$1,350.00.
The only way the 2,815.00 short can be called away is at a profit
Short 2,815.00 called away at 2,740.00 = +$3,750.00 on the futures position.

Write the put at 2,740.00 collect $1,350.00

5.8) Using the 27.00 points collected from the put write = $1,350.00

Buy the 2,890.00 call, cost 16.00 points = -$800.00
Contract value at 2,890.00 = $144,500.00

The call objectively defines risk on the 2,815.00 short on the trade and for the duration of the trading period 1 February 2018 to 9 February 2018

The call also negates any possibility of being stopped out of the position.

The net collected on the collar +9.00 points = +$450.00,

In this example we we’re paid $450.00 to define risk on a position worth $140.750.00 from 1 February 2018 to 9 February 2018.

Buy the call 2,890.00 pay $800.00

6) Potential outcomes for this trade

6.1) The market stays the same and settles on the 9th of February 2018  unchanged from our entry at 2,815.00.

The put wrote at 2,740.00 expires worthless, we keep the 27.00 points = $1,350.00

The 2,815.00 short futures settles unchanged at 2,815.00 = $0.00

The 2,890.00 call purchased expires worthless, we lose 16.00 points = -$800.00

Total bid/ask spreads, commission, exchange & regulatory fees = -$159.78

All in net profit or loss  = +$390.22

6.2) The market moves hard and fast against us

We rally from our short entry at 2,815.00 (contract value = $144,500.00) by 300.00 points +10.66% to 3,115.00 contract value $155,750 in “fast market action”.

During a “fast market” it is difficult if not impossible to liquidate a position (when your on the wrong side). When the market moves far enough trading is suspended and the market is “locked limit” for today’s price limits see this link.

If a  rally like this occured it would have no impact on the maximum risk of our collared position because we own the call.

The call objectively defines our risk on the trade and for the duration of the trading period. The maximum risk (in this example) is the distance between our entry at 2,815.00 contract value $140,750.00 to where our call engaged at 2,890.00 contract value $144,500.00

Loss on the 2,815.00 short futures position is 300.00 points = -$15,000.00

The put we wrote at 2,7400 expires worthless +27.00 points =+$1,350.00

The call we own at 2,890.00 is profitable for 209.00 points =+$10,450.00

Total bid/ask spreads, commission, exchange & regulatory fees = -$159.78

Net loss = -$3,359.78.78 on rally against us of  10.66% in fast market action.

In this example we were paid $+400.00 to prevent a potential loss of $15,000

6.3) Market moves lower 

The trend continues lower,  the contract moves from our entry on the 1st of February 2018 at 2,815.00, contract value $140,750.00 to our profit objective of 2,740.00 contract value $137,000 on or before the 9th of February 2017.

Gain on the 2,815.00 short futures position 75.00 points = $3,750.00

The put we wrote at 2,740.00 is offset by the short futures position  we keep the +27.00 points in collected time premium = +$1,350.00

The call we purchased at 2,890.00 expires worthless -18.00 points = -$800.00

Total bid/ask spreads, commission, exchange & regulatory fees = -$159.78

All in net gain or loss = $4,140.22

7) S&P 500 Collar Spreadsheet

  • Open with Excel
  • Click OK
  • Enable editing
  • Enable content

If you have questions or comments send us a message or  schedule an online review

Regards,
Peter Knight Advisor

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Disclosure

 

 

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Asset Investment Management

Family Office, Advisors