My Favorite Options Trade

Today’s post is the reason that I wanted to provide an explanation of a stock collar.  That is because my favorite options trade of all time involves the use of the collar.  If you missed that post or really don’t understand what a collar is, you should go back and read it.  Otherwise, keep reading.

Now this trade is not mine.  It would be great if it were, because then maybe I would own a professional sports team.  Although I would have chosen football over basketball.  Because this trade is not mine, I am having to go by news reports but the principles remain the same even though I can’t provide the minute details.

How to Save a Billion Dollars

I am sure that you have heard of Mark Cuban, the billionaire owner of the Dallas Mavaricks who won last year’s NBA Championship.  I suspect that you may also know that Mark Cuban became a billionaire by helping to found and grow the company Broadcast.com with a partner, Todd Wagner in 1995.  He ended up selling to Yahoo in 1999 for $5.7 billion in stock.

Now I am not sure where Mark Cuban came up with the idea, but it turned out to be brilliant.  Again, investing in the rearview mirror is easy.  It is managing investments in real time that is difficult.  The 14.6 million Yahoo shares that Cuban had were valued at $95 each or almost $1.4 billion.  That is a lot of wealth to be concentrated in one position so Mark Cuban ended up structuring a collar that allowed for some upside but limited risk of loss.

Here are the details of the trade:

  • A total of 146,000 put contracts with a strike price of $85 per share were purchased.  The cost of these were offset by
  • The sale of 146,000 call contracts at a strike price of $205 per share (zero cost collar)
  • Expiration was 3 years away

What this meant was that Cuban could more than double his money and take advantage of any rise in the stock price of Yahoo up to $205 per share but would only lose $146 million at most.  He could still walk away with $1.2 billion even if the price of Yahoo cratered.

Outcome

Well, it turns out that the price of Yahoo stock rose to $237 per share in January of 2000 which meant that the trade didn’t look all that smart.  But as I have been learning in the stock market, it never pays to get greedy!  That’s because a little over 2 years later in late 2002, the internet bubble had burst and Yahoo was trading at $13 per share.  Brilliant!

The end result was that Mark Cuban managed to save himself $72 per share in lost wealth or just over $1 billion dollars.  Now he was able to diversify into other investments.

Again, I cannot tell you exactly how he came up with the idea but obviously someone who knew how to protect capital and wealth felt that this particular collar trade was a good idea, and I would have to wholeheartedly agree.  And that is why it is my favorite options trade of all time!  Maybe someday, I can replace it with my own.

Readers:  So what do you think?  If you hadn’t heard of the collar, I doubt you would have heard that Mark Cuban managed to execute one with great effectiveness.  But I bet you had heard of Mark Cuban!  Feel free to comment below.

 

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