In January, I will be trading with $500,000.00 so I will use this for the example below. Within Thinkorswim this is called a “Collar with Stock”. Here we go!
Nvidia is having a great day and closed around $185. It went up and, thus, the call premiums are elevated. This is a good time to sell calls, but what if you don’t have any shares? You certainly don’t want to sell naked calls that’s dangerous.
Bullorbust Tip: As the underlying stock price moves higher the call premiums increase and the put premiums decrease. Calls are for going up, Puts are for going down…
Since the stock is moving higher I want to sell calls instead of selling puts (my other love). Since I have no shares and don’t want to be naked, I want to buy stock and sell calls at the same time with put protection (collar with stock). This is what happens in the same transaction with one (1) commission:
SELL NVDA NOV 185 CALLS (25) or 2500 shares worth @ $10.85 per share for a total premium of $27,125.00
BUY 2500 shares of NVDA stock @ $185.39 per share for a total cost of $463,475 leaving roughly 10% in cash.
Bullorbust Tip: They’re only going to charge you $451,000.00 roughly or the difference between the stock price and the credit premium.
BUY NVDA NOV 175 PUTS (25) or 2500 shares worth @ $5.80 per share for a total premium of $14,500.00. This is your insurance policy and you’re going to pay handsomely for it.
This trade will cost you $44.45 in commission with TD Ameritrade.
With this type of trade you are protected from a massive market collapse AND you’re guaranteed a certain amount of premium. You are not making the entire premium as if you simply bought the stock, sold the calls and the stock continued higher or sat where it is now, but your downside is protected and this insurance policy costs you basically half your premium.
Bullorbust Tip: We are not trying to make money on the shares, we simply want the premium during higher Implied Volatility. This is why we don’t care about buying stock and selling calls at the same price / strike. We are only concerned about the premium.
You execute this trade and the next day NVDA is $200 per share. Anything that happens the “next day” will look very bad on paper so you will need to be mentally prepared for that, but it will work itself out at expiration. Short options take time to work their magic. So, you wake up the next day and NVDA is $200 per share – your short calls will have greatly increased in value losing, on paper, what looks to be an ass load of money. This is of no concern because you will not lose more than the premium paid at expiration. The remaining loss will simply disappear along with your shares when the option is exercised (and it will be exercised) at expiration. This is the point.
The shares are covering the calls in case it continues higher, but NO MATTER WHAT you’re going to get paid the $27,125.00 in premium from the calls. The puts on the other hand will be worthless so that protection (insurance policy) that you paid $14,500.00 out of your $27,125.00 premium or a little over half (to make sure you don’t go broke) will be gone.
Ultimately, with this scenario, the best action is no action. Do nothing but wait until expiration and collect your $12,625.00 premium (the call premium minus the put premium is your profit for the trade). Your shares will be gone and everything will disappear and you will be nearly 13k richer! Yay!
You execute this trade and the next day NVDA is $150 per share. This, in my opinion, is the best-case scenario. Why? Because really I don’t mind holding the shares of stock and if this happened the short calls and the long puts would be INCREDIBLY profitable. Based on my calculations (analyzed with thinkorswim) you would be profitable somewhere in the $76,000.00 range on the calls and puts.
YES, your shares would be down $35 or $87,000.00 roughly, but your options are helping to offset the disaster, again, the point. You will be faced with an important and difficult decision so, again, you must be mentally prepared for this event. Always have an entry and exit strategy before executing any trade.
The decision will be to either buy back the calls at probably 2 cents each and take that gain, sell the puts enormously profitable and take that gain and hold the shares OR close all positions and be down $11,900 roughly. Tough decision and it will depend on a lot of variables. That loss is still better than being down $87,000.00 which is what the retail stock purchaser who just bought 2500 shares at $185.00 per share the previous day would be down!! Whew!!
If something terrible is going wrong in the world it might be best to take the 12k hit and relax in cash for a bit. You can also simply hold the shares and wait for a rebound which is probably what I would do, but maybe with a stock that pays a better dividend so I can eat while I wait.
Bullorbust Tip: IF this happened closer to expiration your max loss no matter what is only 14k total or less than 3% of the amount allocated for the trade ($451,450). Remember, the amount allocated is the total cost of the trade minus any actual premium gained.
You patiently wait 38 days and nothing happens. NVDA remains at $185.00 per share or is higher on the third Friday of November. Everything disappears and you clear $12,625.00 in profit after being fully protected. This amount will differ slightly based on what exactly was paid for the stock shares and the options pricing at the time minus commissions, but you get my point.
If you didn’t care about a downside risk with holding the shares (and why would you with NVDA) then you could leave the puts out entirely eliminating your insurance policy and clear nearly $28,000.00 for a month’s worth of waiting. Literally doing nothing but smoking cigars, maybe a little golf and napping a lot.
Bullorbust Tip: If NVDA started to turn over your break-even would be around $175.00 per share so you would have until that price to buy back the calls and sell the shares more than likely even depending on when the downturn happened. This is your failsafe. I rarely hold a trade past break-even if things are not going my way. This takes extreme discipline because you will more than likely lose money, but if the trade goes wrong get out and live to fight another day. Given how NVDA has acted this year I would buy back the calls and keep the shares and ride them back up making money both directions!
No matter which strategy you use or how you leverage options there is simply no better way to make money. You can protect yourself and your cash with simple methods that, in certain scenario’s, might make you even more money!
There are many other scenario’s that I left out because these are the top three (3) choices in my opinion. However, one scenario I like that I did not include is IF NVDA hit $150 the next day you could close the entire collar with stock (buying back the calls, selling the puts and selling the shares) and then turn around and sell at-the-money puts immediately for an enormous premium.
This is the same (really) as holding the shares and riding them back up except one big difference: if the stock inches up or sits around and consolidates for a month you get the entire put premium without the stock moving hardly at all. If you just held the shares hoping it goes back up you make nothing if it sits around.
There are many ways to play this game…this concludes today’s lesson. I hope you enjoyed it!