Collar Option or Married Put can be a very successful strategy if implemented the right way and for the right reasons. Before implementing any strategy, the importance of a having a plan is essential to financial success. No strategy will work consistently if not applied properly to meet goals established before the investment takes place. The interesting thing about the collar option or married put is that it is one strategy that probably allows for an investor to make a mistake with a stock and get out with limited losses.
Collar Strategy Saved This Investor’s Citigroup Stock Investment
For example in July of 2008 an investor friend purchased 1000 shares of Citigroup Stock. To him it made a lot of sense since the dividend was excellent and in the bear market the stock has fallen below $45.00 which he considered a steal since in 2007 it was trading for over $100.00 a share. With a discount of more than 50% in value he was thrilled. He put in place a Collar Option when he bought the January 2009 $40.00 put which cost him $3.90. I am sure you can see where this is going.
Citigroup Stock as everyone know collapsed and by January it had fallen to $8.00. This investor cashed out his shares for $8.40 and sold his puts for $32.75. Stock loss was $31.60. Collar option gain was $32.75 – $3.90 = $28.85. Dividends $4.80. Total Gain thanks to the collar option was $2.05.
Collar Option For Long-Term Dividend Investors
A collar option strategy can be used in different ways. One of the ways I use a collar strategy is to build a long-term dividend capture position in stocks. Dividends are the lifeline I cling to in good and bad times. I need the dividend to protect against inflation and provide income as I age. Dividends unlike bank deposits or bond yields can increase annually if I buy into the right company. A good example would be Johnson and Johnson Stock which when I first bought shares in 1988 was paying .03 cents each quarter. Today the dividend is .57 cents for a gain of 1800% in dividends over 24 years. This is why so many dividend investors purchase dividend paying stocks. I am not interested in just today’s dividend but future dividend increases as well.
The Problem With Dividend Stocks
The problem with dividend stocks though is that they rise and fall like any stock. I have never had a lot of problem with rising stock valuations and like all investors that is the goal of my investing. I want to earn the dividend and see a nice big capital gain somewhere in the future. However even dividend paying stocks get pushed lower in bear markets and large pullbacks.
To understand how I use the collar option or married put in my dividend investing an example is probably easiest to follow.
Collar Option or Married Put Goal
Many dividend investors buy a stock for the dividend and never look back. They do not want to sell, ever. I agree with part of that philosophy except I want to get my capital back faster and reinvest the same capital sooner in other stocks. To do this I use the collar option but with a covered call to help pay or finance for my collar option insurance. The goal then was to get the shares, pick up the dividend and have the stock paid for and my original capital returned in as fast a time as possible. The collar strategy can definitely assist.
Collar Option or Married Put on Kimberly Clark Stock (KMB Stock)
The trade I will discuss is my Kimberly Clark Stock trade. Kimberly Clark Stock symbol is KMB and it trades on New York. I first looked at KMB Stock in early 2002 and with stocks in a bear market I decided I wanted to own this stock for a long-term dividend investment. To get into the stock I sold puts at the $57.50 strike for several months and then on July 19 2002 the stock had an incredibly bad day and fell from 55.05 to close at $52.98. I decided to accept shares rather than roll the put contracts and was assigned at $57.50 for a total outlay of $57,500 less my income made through selling puts.
Timing The Collar Option
Investing successfully needs a strategy. Even a simple strategy like the collar option can make all the difference for consistent profit. My strategy was to use the Fast Stochastic Timing Tool to pick when to buy my collar option or married put and when to sell my covered calls to help pay for the cost of the collar option. I could have added other timing tools including the slow stochastic but my goal was to keep the stock, and pick prime days to sell covered calls and buy the protective put for the collar. I felt the fast stochastic was all I would need. I like to keep trades simple if possible and overall the collar option or married put is simple strategy.
The chart below is from that period in July 2002. On July 19 2002 options expiry, the stock had a terrible day falling 4%. For readers who are interested, in July 2002 the media was filled with stories of the end of America and the demise of the US dollar. They also were filled with panicked investors complaining about the collapse in stocks that July. Most didn’t know there was lots more downside to come.
Collar Option And The Fast Stochastic
On the day the stock fell, the fast stochastic reading was %K 1.42 and %D 6.19. In simple terms if %K is lower than %D, fast stochastic is signalling that the stock is going to move lower. However, the reading of 1.42 for K% is incredible low which normally means a bounce could be coming.
The next day the Fast Stochastic was %K 4.56 and %D 4.25. %K was higher than %D meaning the stock may move back up. It was only a small difference but this still told me there was a good chance of a bounce. You can see in the chart that the stock did recover over the next few trading sessions.
Use The Fast Stochastic To Pick The Best Time To Buy Your Put And Sell Your Covered Calls
I cannot stress enough that using a tool like the Fast Stochastic is important to pick the best moment for buying the collar option. This is because if I had bought my collar option the day after I was assigned shares the cost was very high. This was because the market was collapsing and investors were panicked. With my KMB Stock assigned at $57.50 by July 22 the stock was already below $52.50. The cost to buy a January 2003 $57.50 put was $9.25. The $57.50 January 2003 covered call could be sold for $1.10.
Remember that the Collar Option Is A Protective Put – Think Long Term
When I accepted assignment of the shares I wanted the stock. I wanted to start building a dividend income position in Kimberly Clark Stock. Yet when assigned shares, investors panic as they see the stock collapsing. It is important to forget this. Forget that the stock is falling. Remember the goal and the strategy. The goal was dividend income and to get my money back as quickly as possible. I never want to give up my shares. I want the dividend. The collapsing market will not impact my dividend unless Kimberly Clark goes out of business. I don’t believe that is going to happen. Therefore I looked to the fast stochastic to tell me when to buy that collar option and when to sell the covered call.
I want to buy the collar option when it is cheap. I want to sell the covered call when the premium is high. In order for the protective put to be cheaper the stock needs to rise. For the covered call to bring in better premiums I need the stock to rise. Remember this is a dividend position that is being built. The whole purpose of the trade is to get my capital back asap. In other words I want to earn my $57,500.00 back as quickly as I can so I can invest it in other stocks or maybe buy even more of KMB Stock.
Collar Option or Married Put Is Insurance
The collar option or married put is for insurance against a catastrophic event. It is to protect my capital that I have invested. As I have no plan to sell my shares but to build a dividend portfolio, the protective put can be put on at any time and the best time is when the market has turned around and risen. Every bear market has blood curdling plunges and hair-raising rises. The secret to collar options is to let everyone else ride the bear market rollercoaster and you take advantage of the increased option premiums and wait for the rises.
Wait For The Rise In The Fast Stochastic
Therefore I want to wait for the fast stochastic to rise. I never think about the fact that I took assignment at $57.50 and the stock is already down 10% in ONE DAY. Instead I look at the fast stochastic which on July 22 showed a possible bounce even though the stock had fallen further.
On July 23 KMB Stock climbed and each day of the climb the fast stochastic showed %K higher than %D. On August 1 2002 the fast stochastic reading showed %K at 87.92 and %D at 92.06. %D is now higher, marking a change in market trend. The next day at the open I bought my collar option protective put. I bought the January 2004 $55.00 put for $6.15. I sold the September $62.50 call for .60
There Are Many Collar Option Strategies The Can Be Implemented
There are many variations to the collar option strategies. When I sold the January 2004 $55.00 put I could have also sold the January 2004 $62.50 call to finance the collar option. There would have been a slight loss in the trade of around $500.00 as the call was worth less than the put, despite the put being further away from the present valuation which was $60.00 at the time of selling the call and buying the put. This is because the market was bearish and put premiums were higher.
I Prefer Monthly Covered Calls To Finance The Collar
Part of the reason I do not like going that far out with covered calls on this type of trade is because I have no intention of ever giving up the KMB Shares. By staying to the closest months I have far more control over the movement of the stock and when to buy to close my covered calls early to avoid exercise. However for many investors there is nothing wrong with the strategy of selling the call and buying the put for the same month, but in my case this trade was as a long-term dividend investment. Therefore here is what I did.
Cost To Buy $55 Collar Put = $6.15
Time To Expiration = 18 months.
Monthly Collar Option Cost = $6.15 / 18 = .34 cents
In order to pay or finance the collar options I would need to sell covered calls monthly for .34 cents.
But Remember The Goal
But the goal was to have as much of my original capital from this trade returned to me as soon as possible. As well I had no intention of ever selling the stock. This meant that when the stock fell dramatically I would sell my married put or collar option for profit and not exercise my right to sell the stock at $55.00. I based my decision of when to sell the stock on looking at the years from 1996 to 2002. There is a chart of this near the bottom of this article. I knew that anywhere below $45.00 was under-valuation for KMB Stock and I would sell my collar options near that value as I also know stocks can bounce back quickly.
Here’s What Happened To The Collar Options
The chart below shows what happened in the fall of 2002. When doing this type of trade it is important to remember what type of stock market you are in. In the fall of 2002 it was a severe bear market. All stocks were collapsing and KMB stock was right there with the rest. My Sept, Oct, Nov, Dec and Jan 2003 covered calls all expired. I earned $2.35 in my covered calls. I picked up the Sept 4 and Dec 4 dividends for a total of .60 cents. On Jan 17 I sold my collar options for $12.75. Total income earned = $15.70. Collar Option Cost $6.15. My cost on my stock was now $57.50 less $9.55 = $47.95. At $47.95 I was almost at the $45.00 under-valuation figure I had decided on for KMB Stock.
I had $15700.00 of capital returned which meant I could sell 300 shares or 3 put contracts on KMB at $42.50.
The stock continued to fall another 8% from Jan 17 to a low of $42.20. I never picked up further shares but I did continue selling puts and covered calls.
No Need For Another Immediate Collar Option
The reason I did not immediately buy another protective collar is because of the chart below showing KMB Stock from 1996 to 2002. Over the course of that period the stock had set a low of $35.88 in the 1998 bear market. With the stock below $45.00 I doubted there was much more downside in the stock and at $35.88 I would have bought more shares. I felt selling puts at $42.50 was a nice compromise.
A Second Collar Option Trade
The stock worked its ways higher into the late spring of 2003 and by June 12 with the stock at $54.00 I used the fast stochastic to pinpoint another day to buy another set of protective puts and start the collar option again. It was still a bear market despite what the analysts kept telling everyone. I bought 10 January 2005 $52.50 puts to put my collar strategy back to work.
Collar Option or Married Put For Long-Term Dividend Investors Summary
I cannot show all the trades from the many years in a webpage but I am sure readers understand the concept. Today I have had my $57.50 per share cost in KMB Stock returned to me with the last trades being in 2009 when I was shocked to see KMB Stock fall below $45.00 again.
So why did the collar option work so well?
1) I held the collar option during the bear markets when volatility is the highest. I never forgot that I was in a bear market and to take opportunity of that market including better option premiums for selling my covered calls and for selling my collar options.
2) It was a long-term portfolio investment. I therefore didn’t worry about what price I had paid for my stock once I had bought it. I just wanted my capital returned from the trade as quickly as possible so I could use it for other trades. Therefore as it fell I didn’t worry about any capital loss, but worked the trade for income from the covered calls and profit from the collar options.
3) I used the fast stochastic to time buying the put and selling covered calls. I always waited for a very overbought condition and for %K to turn lower than %D to immediately sell my options.
4) I wasn’t greedy and sold my collar options when the stock fell to what I considered extremes, near the $45.00 price range. This was based on looking at the past years of KMB Stock and determining by just looking at the chart that anywhere below $45 marked under-valued.
5) Again because of the chart I decided it was unnecessary to buy the collar option again once the stock had fallen. This again was determined by my decision that below $45.00 would be a good entry point for more shares and indeed I sold naked puts at $42.50 and would have taken assignment. I saw no reason to buy a collar at a strike I would consider under-valued.
6) I never listened to the analysts who advised that fall that America was on the verge of collapse and stocks were a terrible investment. I decided a long time ago that if the world is going to collapse it really isn’t going to matter if I have my money in a mattress or in stocks. Indeed some of the best stock buys were in the great depression.
7) I took the cost of the collar options and divided it over the number of months to the collar option expiry. I then took that monthly amount as a monthly insurance cost and used covered calls to try to cover most of the collar option cost or basically finance the collar.
8) I sold covered calls out of the money and always when the fast stochastic had risen and was about to fall again. I did not worry about whether I was selling the covered call below my cost basis. I had 1000 shares which allowed for 10 covered calls and that it the total I sold. Whenever the call option fell below .10 cents I watched for the best time to buy to close early and then wait for the fast stochastic to rise once more so I could sell the 10 covered call contracts again.
9) Last, I had a clear goal, clear strategy and never second guessed my decisions which would result in delay of trade executions and normally worse premiums.
This is just one way to make collar options or married put strategies work to both protect and provide a substantial return of the original capital spent. Collar options are a terrific strategy for long-term dividend investors but many investors are unaware of the different collar option or married put strategies and how to properly use them for successful investing.