Hello,
I'm learning about options and came across a Collar with expiration 6mo from now where the break even price is $4 below the current underlying price (according to the optionschart.io).
On top of it the short call leg generates credit which covers the cost of the long put + extra credit. So in the result I'm getting money for the collar.
I've calculated yearly yield of the collar at expiration and it's between 3.7% and 20.6%.
It looks like free money (I know the lower end is below risk-free rate), therefore I wonder where is the catch? What are my risks if do the trade with the real money?
Is the situation when the break even price is below the current underlying price common for collars and what are the best practices for holders of the collar?
Break even is below current underlying price in a collar. Where is the catch?
byu/DeepBluejay4927 inoptions
Posted by DeepBluejay4927
2 Comments
I don’t think there is a catch. When you enter a collar you are effectively locking in a return within a given range. You’re capping downside with the put and capping upside with the call.
However, you need to factor in the value of the underlying shares when considering your return. Getting a net credit for the put/call component of the trade is only part of the equation since you’d need to consider the decline in value of the shares if the put goes ITM.
All that being said, the tighter the strike width between put and call, the more likely you are to guarantee a “profit”, although that return will trail the risk-free rate (see conversions).
I wonder if this is as simple as your not understanding that “breakeven” is [the price the underlying must be at *at expiration*](https://www.reddit.com/r/options/comments/m0m7at/monday_school_your_breakeven_isnt_as_important_as/) in order for you to break even. It’s always possible, on any underlying, using an expiration date, to create a collar where this “breakeven” is below the current underlying price, but this doesn’t mean anything. Immediately after you open a position, the position is still worth the price you opened it for, meaning you would pay/receive the same amount to close it as you received/paid to open it, so you’d break even at that point (you’d actually lose a little money, because of the bid-ask spread.) Prices have to change in order for you to make a profit. If a stock is at 54 and you create a position whose “breakeven” (at expiration) is 50, that doesn’t mean you can open it and then immediately close it for a profit.