Collared Long Positions

While watching the market oscillate for the last few days it has reminded me of how volatile the market can still be. The market continues to search for a direction after having risen more than 30% from its March 9th lows. As a covered call investor it would be wrong for me to either overestimate the veracity of this market bounce, or to underestimate the multitude of dollars still on the sidelines that could come in at any point their is a pullback and send the market higher. Today, on the cusp of breaching a technical barrier around 875, the S&P 500 managed to pull itself back up to close down only 1.7%. This does not however mean that there wont be a further pullback.

I believe that the S&P 500 does have a slight pullback in store for the regular investor like myself, though it may be constrained to a few segments of the economy that would be most impacted by an economic recovery such as commodity stocks. However, as we saw with the financials last year, weakness in one sector can sometimes drag everything down. Due to this fact, I have decided to institute a strategy for new positions I am opening for the near future, unless I see the near term (before June expiration) market dynamics change. In order to compensate for a possible correction to the 825-850 area. I will be selling out of the money calls in order to pay for the purchase of in the money puts. This will allow me to effectively collar any potential losses I have (though it will also cap my gains), so that I wont "lose the house." It also allows me to sell options further out of the money than I may normally, which could potentially yield greater upside if the market decides to go higher from here. On the other hand, if the market dips lower over the next few weeks, I will be able to profit from the drop both from the appreciation of the puts I will have purchased, as well as the depreciation of the calls Ive sold.

Trading Strategy For Covered Calls and Married Puts

For all intents and purposes there are two possible scenarios to address for the trading of the calls I will sell, and the puts I will purchase. If the stock decreases in value substantially enough to buy back the call for a reasonable price I will do so, and keep the put for additional downside protection in case the stock continues to fall. If the stock then rises after this point, I will resell the call that I bought back in order to earn an even greater return. It is important to note here, that this type of situation will most likely only occur with stocks that have fairly high volatility.

I would be interested to hear if anyone else has an opinion, or thoughts on this strategy, so please comment if you wish.