Weekend Review

When there are holiday weekends such as this one I get a half holiday from the Weekend Review as there is no Options Action episode to report on. However, the Striking Price column gave me plenty to talk about.

Barron’s –

The Striking Price column discusses one of my favorite strategies to discuss in the classroom, the collar. The article discusses protecting a market portfolio from a dramatic move to the downside while simultaneously giving up some upside. A trading example is set up using the SPDR S&P ETF Trust (SPY – 141.05). The pricing was from earlier in the week and with SPY around 138.00 the suggestion was to buy a SPY Feb 126 Put for 1.30 and sell a SPY Feb 145 Call for 1.15 which is a net cost of 0.15 and combined with a comparable long position in SPY. With the market rally on Friday and SPY 3 points higher, the same trade could have been implemented on Friday afternoon through purchasing the SPY Feb 126 Put at 0.90 an selling the SPY Feb 145 Call at 1.70 for a net credit of 0.80. As this trade would also involve owning SPY versus the option positions your protection from this point is 15 points lower and you would sacrifice upside only 4 points higher. You would receive a credit, but the risk reward dynamics have changed greatly.

I do have to expand on a couple of things about this article. First, whenever I see SPY as an example or suggested trade, I think SPX options. If you qualify for portfolio margin then there is the possibility of using SPX or SPXPM options in place of SPY. There are many potential distinct benefits of SPX or SPXPM options versus SPY. For one, there is a potential tax benefits through using SPX versus SPY options as SPX (and SPXPM) options are potentially entitled to be taxed at a rate equal to 60% long-term and 40% short-term capital gain or loss which is spelled out under 1256 of the Tax Code. A second benefit is the contract size. If you own 1000 shares of SPY to employ the strategy above using SPY options you would buy 10 puts and sell 10 calls. Using SPX options you would purchase 1 put and sell 1 call as the notional size of an SPX option is just about 10 times that of a SPY option contract. For the trade above, substitute the SPX Feb 1260 Put and SPX Feb 1450 Call combined with long 1000 SPY and you get the same sort of risk reward profile in a potentially more efficient structure. 

Second, the column goes on to talk about being more dynamic around a collar which is something I have been advocating for years. A new study was referenced where a strategy that consistently buys a six month put on SPY and sells a 1 month call on SPY which is combined with being long SPY outperformed a buy and hold in SPY over a 22 month period. Again, I see SPY and think SPX. I quickly dug out the study – Options-Based Risk Management in a Multi-Asset World – figuring I would read it and highlight more of what was in the study in this space. This is something that will need to be done in a future column as the full text is 264 pages. So much for getting a half holiday from my weekend blog…