Lock in Big Winners with the "Profit Collar" Strategy

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.

This Simple Collar Strategy Is Your Key to Bigger Profits

The "Profit Collar" strategy 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 prime-time 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.

Let's return to one of my favorite stocks as an example: Apple Inc. (NASDAQ: 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 Dec. 3, when prices closed at $259.45 on a pullback. That would give you profits of $5,955 or 22.95% as of Feb. 18, when Apple closed at $319 per share (and I'm writing this column).

Putting together a Profit Collar is two-step process...

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For example, you could sell a 21 Feb. 20 $322.50 call for $1.38, then turn around and use that strategy to finance the purchase of a 21 Feb. 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 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.

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 its 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.

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The post How to Lock in Big Winners with "Profit Collars" appeared first on Total Wealth.

About the Author

Keith is a seasoned market analyst and professional trader with more than 37 years of global experience. He is one of very few experts to correctly see both the dot.bomb crisis and the ongoing financial crisis coming ahead of time - and one of even fewer to help millions of investors around the world successfully navigate them both. Forbes hailed him as a "Market Visionary." He is a regular on FOX Business News and Yahoo! Finance, and his observations have been featured in Bloomberg, The Wall Street Journal, WIRED, and MarketWatch. Keith previously led The Money Map Report, Money Map's flagship newsletter, as Chief Investment Strategist, from 20007 to 2020. Keith holds a BS in management and finance from Skidmore College and an MS in international finance (with a focus on Japanese business science) from Chaminade University. He regularly travels the world in search of investment opportunities others don't yet see or understand.

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