How Lock in Big Winners with “Profit Collars”

Keith Fitz-Gerald Feb 21, 2020
2 

JoAnna B. pulled me aside sheepishly in Orlando at the World MoneyShow with a great question recently…

…how do I protect big profits on big winners?

Like many folks who’ve been following along in Total Wealth and our sister publication, Money Map Report, she’s sitting on some really terrific winners but doesn’t quite know how to protect the profits that go with ’em.

It’s a fabulous problem and, frankly, one that more investors would love to have.

Selling is one way to go… but not necessarily the best way to go.

Let me explain.

Selling takes you out of the game completely which means, plainly put, that you miss every penny of the profit potential that could be otherwise be yours, if prices go higher still from here.

Which is why you want to stay “in to win” using simple tactics that can help lock in profits while also preserving your upside.

“Profit Collars” can be an easy, powerful and elegant way to lock in profits if you fear a market reversal.

Millions of savvy investors have enjoyed a monster bull run, and, for the first time since 2009, they are seriously questioning whether that can continue in the face of the coronavirus situation.

That’s a smart move.

I believe China is not telling us anything even remotely resembling the truth and that the situation is on the edge of being totally out of control worldwide. It could easily derail an otherwise superb economic backdrop.

Chances are you’ve heard or seen me say something about this in half a dozen primetime news appearances recently. Or, perhaps you’ve read my feelings on the matter right here in Total Wealth, as well.

Either way, chances are you “get it” just like I get it – savvy investors need to be on guard against a potential market rollover even as the rally looks set to continue.

Which brings me to a Total Wealth Tactic called the “Profit Collar.”

Most investors have never heard of such a thing, and the majority of options traders are only vaguely familiar with the term, if at all.

I like Profit Collars because they are a simple, elegant, and powerful way to limit losses AND ensure profits whenever you fear a rollover but don’t want to get out too early for fear of missing out on more upside.

Conventional collars use sell a combination of calls and puts where in the cost of buying the put is covered from income created by the call. If the stock rises above a certain price, your shares get called away at a profit which is clearly a win. If the stock falls, you sell the put at a profit or you exercise, both of which are also good things.

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Let’s return to one of my favorite stocks as an example: Apple Inc. (NasdaqGS:AAPL).

The stock doubled last year and could easily double again in the next 12 months, which is terrific for everyone on board.

Let’s say, for illustrative purposes, that you own 100 shares from last December 3rd, when prices closed at $259.45 on a pullback. That would give you profits of $5,955 or 22.95% as of February 18th when the Apple closed at $319.00 per share (and I’m writing this column).

Putting together a profit collar is two-step process.

For example, you could sell a 21 February 20 $322.50 Call for $1.38, then turn around and use that strategy to finance the purchase of a 21 February 20 $315 Put for $1.48. Your net cost would be a mere $0.10 per contract as I type not including commissions.

Doing this would mean that you’d be locking in profits of at least $5,555 or 21.41% if you exercised at $315.00 on the 21st when these options expire. Yet, at the same time, you’d still be “in to win” if prices continue to rise to $322.50 or higher, in which case your stock would be called away for a profit of $6,305 or 24.3%, commissions excluded.

If Apple closes between $315 and $322.50 per share on the 21st, you simply write off the transaction and repeat the process for the next options expiration period for merely $0.10 per collar, even as you maintain 100% of the profit potential for another move higher.

What’s really cool about this is that you can repeat the entire process as many times as you like using weekly or monthly options as long as Apple’s stock closes between the two strike prices you pick for your profit collar.

There are also two neat twists that not a lot of folks think about.

First, instead of using puts and calls that expire on the same day, you can buy longer term puts instead of shorter-term puts, while continuing to sell the shorter-term calls.

The thinking here is that you can do this several times – the selling short-term calls part – while continuing to hang on to the longer-term puts as an anchor. For lack of a better term, this is like having installment payments on an otherwise very expensive stock.

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And, second, you could also consider repeating this strategy on any dividend stock that has related options trading against it.

In this case, though, the thinking is that you use the collar to eliminate the possibility of losing money in a stock each time it goes “ex-dividend.” Effectively, the profit collar creates your own “insurance” policy while moving in and out of the stock in pursuit of valuable dividends even as it eliminates or minimizes market risk that would otherwise be there.

The CBOE has a great explanation of all this on their website and I encourage you to check it out if you’re interested. You can read up on that here.

Incidentally, the strategy we’re talking about today – profit collars – also works particularly well on indexes and other expensive stocks where you’d may have limited options during dicey conditions like the present when emotions run high.

In closing, thanks for asking JoAnna!

You’re not alone in your thinking nor in your concerns and I hope this brief explanation helps.

Until next time,

Keith

2 Responses to How Lock in Big Winners with “Profit Collars”

  1. Alibaba says:

    Want to protect profits? Did you ever heard about trailing stops? And KISS rule?…

  2. Keith says:

    Thanks, Alibaba!

    You are correct – the KISS principle is always a better way to go but this article is written to answer a far more specific question from someone who wanted to lock in profits – neither of which is technically possible using a trailing stop. That’s because trailing stops are limit orders that turn into market orders when triggered, which means fills vary and that the orders may or may not be filled under chaotic market conditions.

    Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

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