Collar Strategy Can Protect Your Stocks

Hoping and praying that the stocks that you just bought will go up is not the best strategy to use, however it is the one very often used by the average Joe stock trader who is using simple trading indicators. The only salvation they have is that in bull markets most stocks will go up.

Statistics show that in a bull market about 75% of the stocks will follow the general trend and go up, and in a bear market 75% will also go down. Trading with the trend is the best way to trade as 9 out of 12 stocks will follow the trend and give you the best chance of making gains on your stock purchases.

But what if you own some nice stocks and don’t want to sell when the market is clearly going down, or about to go down?. There are a few tactics that you can consider, both of which involve the use of options, CALL options and PUT options. There is the well known strategy called Covered Calls, and the much lesser known one called the Married Put.

If you are going to trade options it is important that before you start trading you get the best option trading education that you can. You should also practice stock trading until you are comfortable with the process. This is a very important point that must be taken seriously, if you don’t understand the terminology and theory then you should not be trading options. If Put option, Call option, Married Put and Covered Call are new to you then don’t trade until you have studied sufficiently.

Selling calls against your stock in 100 share increments is the basis of the covered call strategy and it can provide about a 2-7% buffer against the loss in stock price. However a bigger drop in the stock price will not be compensated for using the covered call strategy, in general.

Stocks in a bear market, and even in a bull market, can drop quickly on news or earnings releases, as much as 15 to 45% within a month. Using covered calls to protect your stocks will only provide limited protection of less than 7% at best and so will not save you if the stock takes a 40% tumble.

The better solution to providing downside stock protection is the option strategy called the Married Put. As the name suggests the PUT that you buy is used to provide protection when the stock goes down because Put options increase in value when the stock decreases in value. The term married is used because the option that is selected has to be very compatible with the stock, in other words a good match, if the strategy is to work.

The selection of the best Put option is not straight forward and involves several criteria which are listed below:

1. The strike price of the option

2. The current share price

3. Choice of options, in or out of the money

4. Put expiration time

Even though the married Put protection only has a short life span if offers much more protection than the covered call. It can provide as much as 95% loss recovery in the event of a significant drop in the stock price.

The downside of the good protection is that you have buy the Put which is a cash debit whereas the covered call is a credit. But there are ways of off-setting this expense and there is much more to this strategy when executed correctly. The Married Put can be made to just about pay for itself and used to generate very good gains if the market, or stock to be specific, moves a lot.

The general idea of the Collar Trade is to combine the covered call and married Put strategy into one, this is what is called the Collar Trade. In effect you put a collar around the stock, sell a call and buy a PUT. If you do this correctly most of the cost of the Put can be offset by the credit from the covered call so you can protect your stock at almost no cost. Yes this is a great strategy which the general public is unfortunately ignorant of, and most brokers don’t understand.

The strategy that I have outlined above is unknown to the average stock market trader but is one of the best trading systems you could have.

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How to Develop a Trading Edge

First and foremost, you need to realize that only a small percentage of traders are successful at developing an trading psychology and the only reason for them being successful, is because they have learnt how to deal with the aspect of failure.

Developing a trading plan is of fundamental importance as far as trading is concerned. What’s of even greater importance though is that you the trader, manages to convince yourself 100% of the importance of a trading plan. Unless you believe your trading success rests solely on a trading plan, you’ll simply not be willing to invest enough time to develop one.

Likewise, I also emphasize the importance of separating oneself from the larger majority. In other words, one needs to find a trading edge. Remember, the vast majority who decide to trade will end up failing and unless you have an edge, you’ll end up joining them.

You’ve more that likely heard and read that on average; only 20% of people entering the markets are successful and actually make money from trading business. So, when you here me making references to the majority, it’s the group of 80% that I’m referring to.

So, where do these figures come from and how can we be so sure that only 20% of traders make money? I know I don’t have any evidence to back such a statement. In fact, when I first considered it, I was of the opinion that it’s no more than a popular cliche.

Frankly, I can see how such a statement could be backed by evidence unless of course there are accurate audits and precise statistical data.

I’ve spent a considerable amount of time mulling over these figures so it came as a welcome surprise when I became involved in a discussion with someone else who also doubted the accuracy of them.

Interestingly enough, we both agreed that as with other professions, traders fall into one of three categories. On one end of the scale you have the top 20% who are highly successful while on the other end of the scale; you have 20% who fail completely. This in turn leaves us with 60% of traders in between, and this is the group who don’t really fail, but they also don’t make any noticeable achievements either. So, now we can see how the 80% group is made up.

Clearly, the largest percentage of traders falls within the 60% group where they just tend to go with the flow. What is it then that drives others further, thus allowing them to enter the top 20% group?

Given what I do for a living, I firmly believe that most people fear failure to such an extent, that they’re in turn reluctant to take risks. I also believe that far too many people perceive failure to be an entirely negative experience when in fact it need not be.

Years ago when I first started with a trading education, an instructor once said that I should never see failure as failure, but instead, we should rather see failure as an opportunity to improve ourselves. Let’s face it, when you experience failure in a certain area, you’ll be particularly vigilant the next time round in order to avoid making the same errors.

An ideal attitude towards failure can be seen in the likes of Thomas Edison who himself experienced many failures along the road to success. Interestingly enough, Thomas once said that instead of failing, he’s simply discovered thousands of ways which don’t work.

Having come to the conclusion that so many people fear failure, Thomas Edison later added that a large percentage will give up, without actually realizing just how close they are to success.

Of course no trader should be willing to storm ahead blindly but there’s a fine line between caution and the fear of failing. I often have to remind myself that I only live once, in order to give myself that extra bit of encouragement for taking a risk. Of course, I then have to do whatever is necessary in order to prevent myself from worrying about my decision.

If this article leaves you with just one thing, I hope it will encourage you to cast off those shackles which keep you restricted to the middle 60% group. While I certainly don’t advocate throwing caution to the wind, please don’t allow yourself to be intimidated by a fear of failing. Take some risks and face your fears, and you’ll be much more likely to get into the top 20%.