Management Of A Dollar Tree Collar

Dec. 5.11 | About: Dollar Tree, (DLTR)

In a previous article related to Dollar Tree (NASDAQ:DLTR), I illustrated a collar position for realizing a potential profit, even if the price of the stock remains unchanged while also providing protection against a large drop in price. A collar position may be entered by selling a call option against an existing or purchased stock and using some of the proceeds to purchase a protective put option. Prices for the initial position as mentioned in the article as compared to the current values are shown below:

11/14/2011 12/5/2011 Change
Purchase DLTR Stock $78.97 $83.69 $4.72
Sell 2011 Dec 80 Call Option $2.45 $4.10 ($1.65)
Buy 2011 Dec 70 Put Option $0.80 $0.00 ($0.80)
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Total Change $2.27 or +3%
Click to enlarge

If we close the position today, we will realize a 3% profit for the position, and as I alluded to in the previous article, the maximum potential profit for the initial position was 3.5%, so we have very little potential profit left, 0.5%, so at this point we should either close the position or manage the position. As a note of reference, if we had simply been long the Dollar Tree stock, a return of 6% would currently be realized, but this is the price we pay for the put option insurance and generating a profit if the stock price remains unchanged.

For managing the position, I determined using PowerOptions' tools that there aren’t any attractive December collar positions, but there is an attractive January collar position available with a 1.5% return if the stock price is unchanged at expiration in January and a 3.1% return if the price of the stock is greater than or equal to $85 at expiration in January. The new position has a maximum potential loss of 9%.

The specific call option to sell is the 2012 Jan 85 at $1.95 and the put option to purchase is the 2012 75 at $0.70. A profit/loss graph of the new position is shown below:

The proposed order for rolling is shown below:

  • Sell-to-close 2011 Dec 70 Put
  • Buy-to-close 2011 Dec 80 Call
  • Buy-to-open 2012 Jan 75 Put
  • Sell-to-open 2012 Jan 85 Call

The trade may execute as a four-leg trade with the inclusion of closing the 2011 Dec 70 Put option, but it may not execute as there may not be a bid for the 2011 Dec 70 Put, and if this is the case, then alternately a three leg position can be entered as shown below:

  • Buy-to-close 2011 Dec 80 Call
  • Buy-to-open 2012 Jan 75 Put
  • Sell-to-open 2012 Jan 85 Call

Either way (three-leg or four-leg), the net debit to enter for the trade is $2.85 [$4.10 - ($1.95-$0.70)]. So, additional capital will be required to roll this position, $285 per 100 shares.

The new position we are entering has a maximum potential loss of 9%, but in reality it’s more like a 6% maximum potential loss, since we already generated a 3% profit for the initial position.

I will continue to follow this position and post updates.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.