Trading Idea: Equity Collar on Bank of America (BAC)
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As the US financial crisis continues without an end in sight, there are opportunities for protection if you are long holder of certain financial stocks. With so many equity option strategies available, it is up to each individual investor to utilize which strategy to employ. To illustrate my point, I will be entering into a Equity Collar strategy with Bank of America (BAC), benchmarking this strategy against a buy and hold strategy with the same BAC stock.
Equity collars are utilized by investors who are looking to minimize the downside risk of a trade, foregoing upside potential in return for downside protection. As defined by CBOE, an equity collar “consists of the simultaneous purchase of a put option, and the writing of a call option. Both options are out-of-the-money, and usually have the same expiration date.”
Looking at the 6-month chart of BAC with the current volitality, this equity is a perfect candidate to execute an equity collar strategy for my paper-trade portfolio:
Here are the trade details:
Buy 100 shares of BAC @ $29.04/share
Sell 100 shares of Nov 08 30 Call Option @ 2.95/share
Buy 100 shares of Nov 08 27.50 Put Option @ 3.12/share
Net Amount per share is $29.21/share, not including transaction costs.
As mentioned earlier, I will benchmark this paper-trade against a buy and hold stategy to evauluate the effectiveness of this trade. This trade stratey can be used for any equity, specifically any financial stock in this current environment.
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Author Disclosure: At the time of posting, I am neither long nor short LEH. This trade is a “paper” trade and is being used for educational purposes.
3 Comments on this post
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Derek said:
Working through the numbers i get a max gain of just under 3% if the Shares of BAC hit $30 or higher.
Max loss is slightly under 6%. After commissions does it really merit the strategy? Risk at best is 2X greater than reward potential?
Also you said in the article above for the collar to use the same strike price for buying and selling. What were the Nov$30 puts going for at the time of this paper trade?
Now i like options and their ‘potential’, but you need to be right and in a short period of time.. I have stopped trading options as of late.
The cost of this ‘insurance’ or the large spreads between buy/sell or liquidity have made it less appealing.
DH
September 17th, 2008 at 10:04 pm
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