Ever make a sandwich so big and poorly constructed that the second you pick it up, the insides propel themselves out and all you're left with is a few pieces of dry toast?  Me neither, but I can envision it happening.  Keep stacking the vegetables without regard to sound principles of sandwich engineering and you may end up with a floor salad.  Well, I set out to make a short sandwich (reverse collar, you could also call it) on Tuesday, September 12th, hoping for the best, as always, but not preparing all that well for the worst.

Around 3:50 PM, I noted that SVXY had made a quick and ferocious climb during just three days, and I thought I'd take a chance on a little roll back down the hill, the way manual transmission cars tend to do at red lights when traffic is stacked up immediately behind them.  I had no brilliant thesis or compelling can't-lose calculation on my side; I simply sized it up with my bare eyes and took a chance by shorting some shares.  Yet I know that the financial winds produced by Mr. Market can be foul indeed, and I didn't want to be stuck on the wrong side of Party Town during the ongoing public festivities called "Market Rises Forever."  I thought I'd better buy myself an expensive emergency-use-only ticket out.

Searching around for protective calls proved unappealing as SVXY continued to climb for the last few minutes of the day.  I placed an order; no one liked it and it didn't go through; I withdrew the offer and made the uneasy decision to wait until the next day.  There ended my trading day, with SVXY short in my account from 82.55 but the rest of the world trading it at 82.73 (and even higher after the close.)

Next day rolls around and SVXY just keeps climbing.  VIX keeps sinking to the middle of the ten range and sits comfortably there.  Indexes can't decide what to do but SVXY keeps rising, and my blood pressure goes up a little with it.  I still haven't bought the protective calls by mid-day, so I resolved that I'd do so, just after shorting a little more and therefore raising my average shorting price.  At 10:39 on Wednesday morning, September 13th, I shorted some more from 84.11, and for a few minutes it looked like I had made a smart move.  But wouldn't you know it - SVXY rose higher and when it touched 85.00 even, I made a move to double my exposure using the justification that I had not yet bought the protective calls and might as well get the whole thing in place so I could begin the process of learning whether my trade had a chance or not.

At 12.52 PM I shorted from 84.95 to bring my shorting basis now to 84.01.  Though I would have rather waited for better call prices, I thought I should be responsible and go ahead and buy my protective calls.  I like the idea of maximum short profits but I don't like the idea of unlimited damage to my account via naked short shares in a quantity I might be completely incapable of covering.  So I put up the cash to buy an appropriate number of calls for Friday, September 15th for the 84 strike and paid a $1.59 contract price for each one of them (that's $159.00 per contract.)

Now I know a worst-case scenario for this short:  If Friday comes and SVXY has continued to climb, I can exercise my calls and buy to cover for the same price from which I shorted.  The only cost to me will be what I paid for the calls.

To break even at expiration, I need SVXY to fall below my basis by at least $1.59 (I'm ignoring the extra penny right now, pretending I shorted from $84.  I'm also ignoring any commissions so this would be off by several dollars here and there.  Let's keep it simple, though.)  All right, let's be precise, although ignoring commissions.   I shorted from $84.01 and if I want to recoup every last penny spent on those calls, I can just let them expire worthless and buy SVXY to cover at a price $1.59 (the price paid for the calls) lower than my shorting price, which comes out to be 82.42.  If it falls even lower before I close the short, then I net a profit.  If it falls below my shorting price, but just by some amount less than $1.59, then I recover some of the cost of what I paid for the calls.  But the price of the calls is the maximum loss I'll have to realize.  That's where I stand now (as I write this on Wednesday, September 13th.)  I have something else up my sleeve, but let's get to that tomorrow.  Before I go, though, let's talk about whether my long calls will be worth the price paid.  When I shorted SVXY, I opened myself up to unlimited risk.  If, on options expiration day, SVXY ends higher than a certain price, which can be determined via this calculation: the price from which I shorted PLUS the price paid for my calls (or 84.01 plus 1.59 which equals 85.60), then it will turn out to be worth the money, at least, assuming I would not want to keep the short open past that day.  Because that cost would be the same as if I had never bought the calls, yet decided to cash in the short (at 85.60) and take a loss of exactly the same amount per share (1.59) as what it turns out I did, instead, pay for the calls.  Every penny SVXY ticks up costs me more money, but at least now I know a maximum cost to me, assuming I exercise my calls before expiration.  Had I not bought those calls, the sky would be the limit as far as potential damage to my account.  Let's adjourn until tomorrow (Thursday), now.

**MINOR UPDATE Captain's Log, star date Sept. 13th 4:30 PM**  I could not resist the tempting profits on the long calls and kept a small fraction of them, selling the majority of them for 2.10, when I had bought them for 1.59, or a profit of 0.51 per contract.  The intent is to wait for a lower entry point and re-buy them... OR NOT.  (insert unsettling laughter sound here, echoing and distorted.)

Writing on Thursday, September 14th during the pre-market hours, I can now report that I bought shares to cover my short shares in a rag-tag assortment of lots, some of them at my preferred price and some not even near it (when am I going to learn to place my limit orders with more generous, um... limits?) and that, of course, is because I had to cancel a partially filled order and put it through again for a profitable, but not nearly as profitable, price.  The 84.01 shorting price turned into cover prices of 83.68 and 83.94.

Now, darned tootin' glad that I sold most of the calls yesterday, I turn my attention to selling the remainder of the calls at my first possible convenience and/or at the moment I sense that the price of those calls won't keep going up.  Options often go from valuable at varying prices to not valuable at all before expiration, as everyone knows, so my task will be to monitor SVXY which is influenced by the VIX which has something to do with what the party-forever market-never-stumbles culture that SPX currently resides within.

As you can see in the pink ink above, between one paragraph and the next, I was able to get rid of the last contracts, and for 1.65.  So, having bought at 1.59 and sold for 2.10 and 1.65, with profits also made on the short shares, I wrap up this trade without complaining.  It was meant to be so much more, though.  Why does the title mention a collar?  I had envisioned the short going my way immediately at which time I would sell out-of-the-money puts.  Paying myself back for the purchased calls is the idea; I've done it before (see previous blog posts) but this time I didn't even get to pop my collar.

Everything went against me multiple times, but I was able to get out and avoid plenty of damage I signed on the line for.  I started with a naked short, and even held it overnight, which of course exposes the holder to unlimited risk.  Then I bought calls with a known possible total loss of $159 per contract.  Instead, I ended up making $41 per contract, and $14.75 per each 100 shares of the short, so added together, I made $55.75 per each block of 100 shares of SVXY shorted.  The security went from 82.55 at the outset of this trade to 85.04 at 9:48 AM today, September 14th when I closed the last of the trade out.  How did I profit from a short of SVXY when it only went up while my trade was open?

Careful handling of all the dangerous moving parts, that's how.  And I'm glad I was able to do it.  Until next time...