A Look at Rule #5: Harvest Gains and Losses

by Jay Pestrichelli on October 20th, 2011

Although it’s the last of the Iron Rules, it’s the one that forces you to pay most attention once you’ve made an investment. For those of you that use a collar or bullish spread strategy, you may find underlying assets (Stocks, ETFs or an indexes) pushing up against your upper limits as we approach October expiration. Most likely, this means that you’re profitable on the trade and that’s a good thing. But it’s time to consider if we harvest or not.

The last 3 weeks of a rising market forces us to ask, what do I do next? Do I let my SPY collar get the asset called away at 120 or roll it to the next month? Do I reset my hedge level due to the upward movement? Do I hold out on those SPX 1200 puts I wrote hoping they stay out-of-the-money? Or even crazier, do I let the QQQ 56 call short leg of my spread get assigned, putting me short the actual ETF in case of a pullback?

Lets look at just the collar:
Lets look at a hypothetical SPY collar with calls written at the 120 strike. The underlying has appreciated nicely from 113 to 121 in the last 3 weeks. That’s a nice rebound as the ETF continues to trade in the range it’s bounced around in since August. The long dated hedges of 103 puts haven’t depreciated enough to warrant action at this time, although it’s worth considering moving them higher at a future date.

If I’d like to continue to hold the ETF, then rolling it up to a November call makes sense. Today, I can roll into the November period and move up the call’s strike from 120 to 125 and make about 60 cents in the process. The benefits are that I get another month of income to pay for my puts, I get a higher assignment price if the stock goes up, and I get another month of dividends. These are all good things.

I repeat, I do this if I want to continue to hold the ETF…which I do. This means I’m not harvesting anything just yet. I’m leaving my Capital at Risk the same, but generating a little extra income to pay for the hedge at 103.

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