Careful how you pop that collar

Backtest Notebooks

It’s important to know when to roll ‘em.

No matter what kind of options position you have on, it’s going to get tested at some point. If it wasn’t you wouldn’t have needed the structure in the first place. Whether you’re using options to hedge your position or accelerate underlying exposure, how you manage losers has a huge impact on results.

A fundamental aspect of the options pricing model says that so long as there’s time on the clock, an option will still have some value. When we roll a trade, we’re capturing some of that remainder and using it for an adjustment.

There’s not much need to roll a daily trade. Sometimes you’ll want to tailor a weekly position, but for the most part with short term opportunity capture it’s about taking a shot, and seeing the result.

As we move into longer term positions, and structures where options are used as investment overlays, rolling becomes more interesting. It could be taking profit on a covered call and pushing it out to a back month, or tailoring the hedge structure as the underlying moves.

A lot can happen in ninety days, let alone a year. Our standard time frames on hedged equity trades is to reset quarterly. The S&P 500 is up almost 10% in the last 3 months. That’s a big difference.

With collars, expiration might be even further in the future. When collars are used to lock up position value, it makes sense to trade them relatively far out. There are potential tax benefits to realizing gains/losses long term, and the basic maintenance and transaction costs are lower.

A basic at the money collar will move “delta one” against your underlying position. 100 deltas of stock versus 100 relatively immutable deltas of options. (Bonus question - do you set at the money at spot price, or at the zero cost level? What’s the difference?)

However as all of finance is wont to do, there are ways to get cheekier with the position. Hedged equity offers a flavor of this, with put spread collars funded by out of the money calls. A little bit of wiggle room to participate in gains, but protection in case things get dicey.

Even with a simple long put, short call collar, there are infinite knobs to adjust for out of the money percentages and collection amounts. Those are all easily plotted on a PnL chart - but that only shows the value at expiration.

What if we introduce rolling rules for our collar? Is it possible to dynamically adjust the position such that we remain protected, but also adjust to continue participating in gains?

Today in the Backtest Notebooks, we’ll analyze a series of rolling conditions for collar trades. How much protection do we sacrifice to keep notching up the gains?