Should We Short a Put to Help Fund a Collar Trade?

1. Covered call trade + protective put.

2. Collar trade has 3 legs

• -Long STOCK (buy)
• -Short call (sell)
• - Long Put (buy)

3. Should we add a 4th leg by selling PUT as well?

-To fund the protective put.

All traded on 10/9/2018

• Buy 100 NVDA at 264.24 (now a long stock position)
• Sell 1x 265 call at 14.45 (now a covered trade)
• Buy 1x 250 Put at 8.20 (now a collar trade)
• Sell 1x 245 put for 6.65 (covered call on the upside and bear put spread on the bottom side)

Adding a Short Put to fund the cost of the Long Put: Advantages

• By generating a premium of $6.65, $8.20 cost of the protective put is reduced to $1.55
• The initial calculations then became:                                                                                 -14.45 - 1.555 = $12.90 = 4.9% ( on a cost basis of $264.24)
• This is more than double the collar initial time value return

Adding a Short Put to fund the cost of the Long Put: Disadvantages

• By selling the deeper OTM put (245.00 strike) we are  incurring additional risk to the downside. 
• If the price moves below 245.00 strike, we start losing money on that leg of the trade as the strike now is in ITM and has an intrinsic value component.
• That risk can be quantified in a worst case scenario a follows:-            
• 245-6.65 = 238.35 per share
• Of course we would take exit strategy steps before letting the trade get that far out of control, but the risk should be understood and qualified before entering the trade.

• Discussion
• When establishing our covered call positions ,  we must define3 our personal risk-tolerance and set up our trades accordingly.. 
• If we require additional protection to the downsize, a protective put is a reasonable approach.
• Like most insurance policies, we must pay for this protection and our initial results will then decline.
• If a short put added to mitigate the cost of Long put, we 2ill then be adding additional risk which is what we were trying to avoid by buying the protective put.

 * https://www.youtube.com/watch?v=TcF12X4uljg&t=435s 

Explaining “Bought-Up” Value When Rolling a Covered Call Out-And-Up

 We can roll out to the same strike at a later date or out-and-up to a higher strike at a later date. For both, there will be an intrinsic-value cost-to-close. When we roll out-and-up, we will benefit from share value being worth more than prior to closing the original short call. In our BCI methodology, this gain is referred to as bought-up value. This article will detail all the explanatory calculations.

Hypothetical trade

• 5/24/2021: Buy 100 x BCI at $48.00.
• 5/24/2021: STO (sell-to-open) 6/18/2021 $50.00 call at $1.50.
• 6/18/2021: BCI is trading at $52.00 as expiration approaches.
• 6/18/2021: BTC (buy-to-close) the 6/18/2021 $50.00 call at $2.10 ($2.00 intrinsic-value + $0.10 time-value).
• 6/18/2021: STO the 7/16/2021 $55.00 call at $1.00 (rolling-out-and-up).

Initial trade structuring (multiple tab of the Ellman Calculator)

BCI - initial calculations

The initial time-value return is 3.1% (yellow cell) with the possibility of an additional 4.2% of upside potential (brown cell) if BCI moves up to or above the $50.00 strike by expiration. As long as the contract obligation to sell at $50.00 is in place, our shares cannot be worth more than $50.00. This is how the trade is structured.

Rolling-out-and-up: information into the “What Now” tab of the BCI Calculators 

Rolling-Out-And-Up Data Entries

Rolling-out-and-up: final calculations from the “What Now” tab of the Ellman Calculators 

BCI: Rolling-Out-And-Up Final Calculations

The bought-up value is $2.00 per share or $200.00 per-contract. This is because shares can only be worth $50.00 with the original short call in place, but once the short call is closed, shares are worth market value of $52.00. This bought-up value must be incorporated into our calculations since we paid for it in the form of intrinsic-value cost-to-close.

The final calculations show an initial time value + bought-up value combined return of 1.8% (brown cell). If share price moves up to the new out-of-the-money $55.00 strike by expiration (an additional $3.00 per-share), the total one-month return will be 7.80% (Yellow cell).

Discussion

When rolling an ITM strike out-and-up, there will be an intrinsic-value cost-to-close. There will also be an unrealized increase in share value by that intrinsic value amount. In the BCI methodology, this is known as bought-up value and must be incorporated into our rolling calculations.