Retire on 30,000

Maximizing Returns and Minimizing Risk: An In-Depth Look at a Bank of America Collar Strategy

This article explores a sophisticated yet potentially low-risk investment strategy involving Bank of America (BAC) stock. This approach combines stock ownership with options trading to generate income while providing a safety net against significant market downturns. Let’s delve into the mechanics, potential returns, and safety aspects of this strategy.

The Strategy: A Protective Collar on Bank of America

The core of this strategy involves three key actions:

1. Purchasing Bank of America Stock: An investor buys 1200 shares of BAC stock at a price of $35 per share. This represents an initial investment of $42,000 (1200 shares x $35).
2. Buying Protective Put Options: To safeguard against a potential price decline, the investor purchases 12 put options, each covering 100 shares, with a strike price of $45. These put options have an 18-month (approximately 75 weeks) expiration and cost $10.40 per share, totaling $12,480 (1200 shares x $10.40). These put options give the investor the right, but not the obligation, to sell their BAC shares at $45 anytime before the expiration date.¹
3. Selling Weekly Covered Call Options: To generate income, the investor sells call options each week for the 75 weeks covered by the put options. Each week, 12 call options, each covering 100 shares, are sold with a strike price above the current market price for a premium of $1.00 per share, generating $1200 in income per week (1200 shares x $1.00). A covered call strategy involves selling call options on stock that the investor already owns.² By selling a call option, the investor gives the buyer the right to purchase their shares at the specified strike price by the expiration date.²

Calculating the Potential Returns

Let’s break down the potential financial outcomes of this strategy over the 75-week period:

• Initial Investment:

• Cost of 1200 BAC shares: $42,000
• Cost of the 12 $45 put options: $12,480
• Total Initial Investment: $54,480
• Income from Covered Calls:

• Weekly premium per share: $1.00
• Number of shares: 1200
• Weekly income: $1200
• Number of weeks: 75
• Total Income from Covered Calls: $90,000
• Outcome at Put Option Expiration (Worst-Case Scenario):

• If the price of BAC stock is below $45 at the put option’s expiration, the investor can exercise their put options and sell their 1200 shares for $45 per share.²²
• Proceeds from selling shares via the puts: $54,000 (1200 shares x $45)
• Net Profit (Worst-Case Scenario):

• Total income from covered calls: $90,000
• Proceeds from put options: $54,000
• Total received: $144,000
• Initial investment: $54,480
• Net Profit: $89,520
• Return on Investment (ROI) (Worst-Case Scenario):

• Net profit: $89,520
• Initial investment: $54,480
• Total ROI: Approximately 164.3%
• Annualized ROI (Worst-Case Scenario):

• Holding period: 18 months = 1.5 years
• Annualized ROI = (1 + 1.643)^(1 / 1.5) – 1
• Annualized ROI: Approximately 84.6%

Safety and Risk Mitigation

This strategy incorporates protective put options, which act as a form of insurance against a significant drop in the price of BAC stock.¹ By purchasing the put options with a $45 strike price, the investor has effectively set a floor on the selling price of their shares. Even if the market price of BAC falls below $45, the investor retains the right to sell at this price, limiting their downside risk.²

The weekly selling of covered calls generates a consistent income stream, which further enhances the overall return and provides a small buffer against potential price declines.²

However, it’s crucial to acknowledge that this strategy is not entirely risk-free:

• Opportunity Cost: By selling covered calls, the investor caps their potential upside gain. If the price of BAC stock rises significantly above the call option’s strike price (which is assumed to be above $45 to consistently generate a $1 premium), the investor will not fully participate in that upward movement.²
• Risk of Early Assignment: Although less likely with out-of-the-money call options, there’s a possibility of early assignment, especially if BAC pays a dividend.²² If the call option buyer exercises their option early, the investor would be obligated to sell their shares at the call’s strike price before the put option expires.
• Fluctuations in Call Premium: The $1 weekly premium is an assumption. Actual premiums will fluctuate based on market volatility, the strike price of the call option, and the time until expiration.² Lower premiums would reduce the overall return.
• Transaction Costs: Brokerage commissions for buying the stock, purchasing the put options, and selling the call options have not been factored into these calculations and would reduce the net profit.²

Rolling Covered Calls

To potentially enhance returns or manage the risk of early assignment, the investor could employ a strategy called “rolling”.¹¹ If the price of BAC stock rises towards the strike price of the sold call option, the investor could “roll up” the call by buying back the existing call and selling a new call with a higher strike price, potentially capturing more upside.⁴² Alternatively, if the expiration of the weekly call is approaching, the investor could “roll out” by buying back the current call and selling a new one with a later expiration date, continuing to generate income.⁴² These rolling strategies can provide flexibility in managing the position based on market movements.⁴²

Conclusion

The described Bank of America collar strategy, involving 1200 shares and corresponding options, offers a compelling approach to potentially generate significant returns while incorporating a substantial level of downside protection through the purchase of protective put options. The consistent income from selling weekly covered calls further enhances the attractiveness of this strategy. While not entirely without risks, the defined nature of the potential outcomes makes it a strategy worth considering for investors seeking to balance income generation with risk management in their portfolio. As with any investment strategy, a thorough understanding of the underlying mechanics and potential risks is crucial before implementation.

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