My Finance professor in grad school needs to read your blog….

The point you made is that in retirement minimize risk as much as possible, all while getting some income… agreed

One thing is “parking”, sometime just stting there you can get hit from the side or back while your sleeping.

Have to be watchful of all of ones investments and to plan (hate that word) to look at every option or possibility that may take any equity down.

That was the point I tried to make on protecting the downside. But Yes we are in agreement on minimal risk for Sally, as always, the problem is … there are no guarantees in the world of finance or the stock market

I think you missed what I was suggesting. She should dollar cost average while *selling* her ETFs by starting well before retirement (5 years +). She can buy dividend stocks or fixed income as she sells ETFs. This way she can reduce the effect of market volatility both on selling her ETFs and buying her fixed income/dividend investments.

If Sally uses this collar technique, she may protect the value of her ETFs but it does nothing to protect her from paticularily low interest rates on fixed income when she is buying. For instance GICs are paying a measly 3-4.5% right now. Her only other option is to park her proceeds from the sale of the ETFs and wait for interest rates to improve.

Wow, that said Al, how does sally protect her life savings and hedge while getting a retirement income.

I suppose what preet is trying to do for about to retire sally, is to maintain capital then take her to the next stage and provide a safe secure reasonable income on retirement.

Its possible Al with what Preet said on the collar was to give an example and show one method to save (protect) her fortune. But my take is that also I would like to get sally some residual income as well as protect on the downslide.

On retirement. I agree a nice balanced portfolio, possibly segregated funds, dividend paying and the other part of her cash in safe protected ETF’s with downslide protection (any which way possible)

Its a great world if the market moved in only one direction

Even WDAMMG is too long. Ah, the power of hindsight….

Indeed, you made a good point.

On SPY the most favourable of all stocks, or even the options themselves, but you need to watch the volatility and the options.

Such great volume, movement in the stock is a buck or two each day, even just wrting a call or put at the money (ATM) could yield 5% – 10% per day, without looking at calendars, spreads butterflies or condors.

Has anyone noticed the relationship between the ^VIX and SPY, they can be used in combination with any stocks that you hold to protect (hedge) the downside and make some money.

Anyone here ever traded the ^VIX

I did not have the heart to type the full name (even c&p, so forgive me)

One approch that I use on the long contract is selling a covered call in the money to offset the downslide (said that before) and used the example recently of GM at $20 and always making sure that I get a premium on the contract sold.

Example: GM JAN 09 $10 call, paying $11 for the contract … a $1 premium over and above the contract strike price and $10 protection on the downside. Maybe pick up some dividend in between.

It has been my experience that a stock that floats around its current price when you write the contract (sell the covered call) you are generally not called till close to the contract expiration date, at which time all being equal, the contract could be bought back at a fraction.

Should the stock go down anywhere between $20 – $11 you’re totally covered. Another option with the $1 premium is to buy a put at say $15 or $10. Only pick up would be the dividend.

Covered call contracts are not cast in stone, they can be bought and sold between the write date and expiry … several times in fact.

LEAPS are wonderful options to hedge against any stock that you hold (even ETF’s) and for getting a premium as well as any dividends

Here is the data:

On Mar 1 2007, POW was trading at $38.00. You could buy an October ‘07 $38 put for $1.65. You could sell an October $40 call for $1.70. So in this case you are getting a net income on the options and your return range is between +0.13% and +5.39%.

A $42 call and $44 call could be sold for $0.95 and $0.50 respectively. Buying a 38 put and selling a 42 call would give you a range of -1.8% to 8.7%. Buying a 38 put and selling a 44 call would give you a range of -3.0% and 12.7%.

Note: In all cases, just because there is an upper range doesn’t mean you will get that return, it only denotes the maximum possible return you could be entitled to if the security actually did go up to that value (or beyond).

You would have to hunt to get a range of 0-8% or -0.5 to 9.5% like in the example in the post – but it is possible, however the norm is for narrower spreads.

As to your question as to when to use an equity collar, I would venture to say that if someone (in a registered account) wanted a safe 3% return, just buy a GIC or 1 year Gov bond for the best insurance. For non-registered accounts where there may be a sizable gain, perhaps this looks more attractive if you need to defer taxes for a year (i.e. maybe you have another extraordinary gain from the sale of a business this tax year, etc.)

And yes, the option pricing environment can change so the spread for a “free” collar can be more favourable. When markets are volatile, option prices generally increase since the chance of hitting the strike prices increases if the underlying security is expected to have big swings (up or down).

So to sum, the strategy can look better or worse depending on market conditions. Even when it looks more attractive, if you are a long term investor with a long time horizon the old buy and hold with nothing fancy will probably win out more often than not. :)

The only thing I could add to JR’s excellent comment is that most people match the lengths of the contracts (the puts and calls). Generally, it doesn’t seem prudent to me to have the puts expire before your target date if you want the protection afforded. (i.e. if Sally wasn’t going to change her portfolio mix down to 50/50 Equity/Fixed Income until December and her puts expired in November, she is unprotected from a market decline for one month.)

Mr. A: You are quite right in that the pricing of options is subject to some of the same gyrations as the underlying security since options trade like stocks with bid/asks. I just looked up the prices for XIU options. The screen showed the current price of XIU as 84.93.

The last trade price of buying a December 08 put on XIU for a strike price of 85 was $5.47. The last trade price of selling a December 08 call on XIU at 85 was $5.85. Therefore for free insurance on the stock (minus some trading costs which are low enough today with discount brokers that it won’t figure in significantly for this little example), will not cost you anything out of pocket (in fact you would net $0.38 per stock), but of course you are foregoing the opportunity cost of the market rising. But again, you are right – this does not always hold true and it may cost you out of pocket to protect the portfolio (if the income from the call didn’t cover the cost of the put).

A number of factors will determine if pure loss protection is “free” (or costs you money), and if your goal is for free (or low cost) insurance the possible range of portfolio returns will be in part determined by the market’s outlook. So for example in Sally’s case we started with a range of -0.5 to 9.5, then moved to 0.0 to 8% by lowering the strike price of the calls. Depending on market conditions, perhaps the range could be 0.0% to 5%, or -1.0% to 6.0%, etc. It’s very much dynamic.

Also, more importantly – this is not really something for a long term investor with a very distant requirement of money from the portfolio. Since markets tend to go up over very long periods of time, you would be better off just holding your positions and waiting for them to go up (or back up) without capping any annual gains.

Are today’s option prices on SPY unusual? Perhaps the equity collar should only be used when option prices are favourable?

Are you suggesting sally not buy the stock but simply write option contracts doing anyone of say a strangle or straddle?

What happens then with the time decay (depending how far out the contracts are) and what-if the stock swings like crazy, even drops or increases by 20, even 30% then what?

Question on hedging is (assuming sally holds the stock), how does sally make decent money (even if she borrowed the money at prime) no matter which way the market goes.

I think Preet was as close as it gets on hedging and making money with the covered collar appeared to be a guaranteed no-lose.

But hey, if someone has a better solution, I’m willing to learn.

Let’s try another example, let’s say the market is very good and Sally wants at least prime rate return on her portfolio. She would buy her put options at that price and sell her call options, say 1% above prime. If she could do it, she could then borrow money from the bank at prime rate and guarantee to make very high returns. Again, not very likely.

In the end, Sally can only expand her collar from the share price that the market think it would be after a year.

Selling the call option long gets sally more money, as would buying the put long would cost more.

The example was to show how to protect the stock doing a collar.

Some familiar with optioning trading would sell the call long and buy puts short (pennies), month after month till the objective target is reached.

At some point in time (assuming sally wasn’t called) and supposing the stock was not moving around too much, sally could buy the call back and profit from the option call she wrote

In this case the example showed the guaranteed 10% return … sweet