On Minyanville today I read an article on using LEAPS with collars to lock in profits or limit risk. Overall, I like the idea of using collars selectively to limit risk on synthetic stock trades, but this example puts an interesting twist on a long call vertical. One problem, the numbers used don’t make any sense
The profit curve for this trade isn’t as clear as it seems, and I have no idea where he’s getting his numbers. There was a typo for the put premium he paid and so I’m assuming the Jan 220 put was purchased for $20 and the Jan 260 call was sold for $19. The net cost on this position is $26 since the premium from the Jan 260 call is used to purchase the Jan 220 put fora $1 debit, and the Oct 230 call is purchased for $25. Since the Oct 230 is purchased their isn’t technically any gain on this stock until it’s over $300. Let’s assume that e meant to use a Jan 230 call and that he could have purcahsed it for $25. The maximum gain on this trade is $4 at expiration and is calculated by the purchase of the stock at $230 and the sale at $260 minus the $26 cost. He mentions a $25 credit from the collar, but he says that he sold the 260 call for only $19.
Assuming the Jan long call instead of October, the risk and reward was completely off in this article. If the stock trades between $220 and $230 at expiration the risk is $26 a share and not $15. I’m getting dizzy trying tomake sense of it, and so I’m going to stop before I throw up.
Here is a P/L graph if this trade was constructed day using all Jan options. I entered several price slices to reflect the loss at expiration. An October 230 long call would only look moderately better. The issue with this trade is that an ATM call option is purchased and the collar can’t be enteredfor a credit.