LLY Chart – Collar Example #1

NOTES ON ELI LILLY (LLY)
Collar

1. In a one month span from Nov. 18, 2002 to Dec. 18, 2002 LLY traded from just below $60.00 to just below $70.00 and back down to $62.00.

2. In another one month span from late May 2003 to mid-June 2003, LLY traded from $56.00 up to $72.00.

3. Several gap openings are also apparent with one in mid-January 2003, one in late August and one in very late September. These all point to periods of high or increasing volatility.

4. We also want to notice the individual daily trading ranges. The length of the lines shows the number of large range days. The longer lines indicate larger intraday ranges. In the chart above, LLY shows a very high number of large intraday movement days, again pointing to high volatility.

5. As much as LLY had strong run-ups, it had some large down periods also. In a 2 month period from mid-Jan. to mid-March 2003, LLY traded down from $68.50 to $58.00. Then in another two month period, mid-June to mid August 2003, LLY traded down from $71.00 to $61.00.

Conclusion: LLY appears to be a very volatile stock during the observed period charted above. The stock began this period at around $60.00 and finished the period at $67.00, which is not necessarily a large move. But when we look at the large intra-month ranges, it’s clear that LLY has been very volatile during this period.

With this type of movement, a maximum protection strategy is necessary but, with such high volatility, premiums will likely be expensive. The outright buying of a put may cut too deeply into potential profits making the risk reward scenario unjustified.

The collar strategy, however, will provide the necessary downside protection, while still allowing room for some capital appreciation. The sale of the call will offset the cost of the put purchase to make the trade’s risk/reward scenario more viable. The collar can be leaned to provide either more protection or more capital appreciation, depending on the investors short term outlook.

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