Part 3: The Covered Call Collar
The Covered Call Collar is an options trading strategy that traders can use to protect an existing position that has recently surged into a key resistance level. Rather than simply taking profits on the share position and potentially missing out on future upside, the trader enters into a Covered Call Collar. This options trading strategy seeks to protect your existing share position while still participating in some of the upside for a minimal or no outlay.
The Covered Call Collar allows you to participate in some of the future gains up to the sold strike price, while being protected by the put position.
Covered Call Collar: ideal for participating in future gains, while being protected on the downside.
If you are of the opinion that the stock is likely to sell-off with little chance of breaking the key resistance level, but you still want to hold on to it, you could use a Covered Call Collar options strategy. The Covered Call Collar strategy is similar to the protective put options strategy in that you also buy put options as protection. The difference is that you will now finance the purchase of those put options with the proceeds from writing an equal number of out of the money call options.
The position will still protect you from losses below the strike price of the put options at minimal to no cost to yourself, but it will also stop the position from profiting beyond the strike price of the short call options should the stock stage a rally. That is, you would miss out on a strong rally in exchange for putting on the protection of the put options for next to no cost (apart from commissions, of course).
Use a Covered Call Collar when you expect the share price to move modestly higher or pull back significantly from current levels.
Recent Trade: Newcrest Mining (NCM)
A recent trade which is yet to pay off was Newcrest Mining. We initially entered the share position when the stock price broke above its 50 and 200 day moving averages, around $38.50. It shot up soon after we entered the trade and has now been trading sideways for the past few weeks. We considered a covered collar was appropriate for this position. Based on technical analysis you can see from the chart that the $42.50 resistance level has held for over a year.
So we bought protection at $39.00 by buying 3900 SEP11 Put for $0.645 and then wrote the $42.50 SEP11 Calls for $0.775. We received a credit for this trade and the position remains open. We are protected until September expiry down to $39.00 and profits will be capped at $42.50.
Chart 1: Newcrest Mining Covered Call Collar Trade
You can plan and analyse your trade as shown above, using the Derivative Profiler option in the Market Analyser software.
MarketAnalyser also provides a payoff diagram for further trade analysis as follows:
Chart 2: The payoff diagram for the Newcrest Covered Call Collar trade.
Trade Note
Newcrest (NCM) is still trading between the $39.00 and $42.50 option strike levels and only time will tell whether the share price will end up at expiry, but we are protected until September expiry down to $39.00 and profits will be capped at $42.50.
The Trade
Options can be used in order to reduce your risk while still participating in potential profits from a modest move in the underlying stock. Here we’ve explained the Covered Call Collar strategy which allows you to participate in some of the future gains up to the sold strike price, while being protected by the put position.
In future articles we will talk about the High Yield Covered Call strategy and the Stock Repair strategy which is particularly relevant to this market.
Utilise the features in the Market Analyser software to plan your trades for the particular options strategy using your specific trade selection criteria. You will save time and potentially reduce your trading risk. Sign up for a free 14-day software trial here.
By Michael Hevern
Head of Research
See Also:
Options Trading for All Types of Market Environments (Part 1): The Protective Put
Options Trading for All Types of Market Environments (Part 2): The Covered Call
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Tags: covered call, Financial Advisory, Market Analyser, Newcrest Mining, options, options trading, Trading Strategies
The put protection in the Covered Call Collar options strategy is certainly very relevant to the current market situation. The Dow moved through 400-points daily the last four days.