Collar strategies snare better performance with less risk, say authors
By Kevin Olsen | May 3, 2012 6:04 pm
Options-based collar strategies would have outperformed the market in most asset classes while providing drastically reduced risk leading up to the financial crisis and the subsequent recovery, according to new research.
“The contagion across asset classes during the financial crisis suggests that protective options-based investment strategies, such as collars, when implemented on a wide range of asset classes, could provide portfolios with greater downside risk protection than standard multiasset diversification programs,” according to a summary release issued by the Options Industry Council, which helped sponsor the research by Edward Szado and Thomas Schneewies. Mr. Szado is a research analyst and Mr. Schneewies a professor of finance, Isenberg School of Management, University of Massachusetts.
A collar strategy is created by purchasing an out-of-the-money put option while simultaneously writing an out-of-the-money call option to lock in gains and provide downside protection.
“This collar strategy clearly gives you a significant risk reduction and often in cases gives you a better outright cumulative return,” said Phil Gocke, managing director of the Options Industry Council in a telephone interview.
The research covers the 55 months from June 2007 to Dec. 31, 2011, and expands on a 2010 paper that studied the effects of a collar strategy against the PowerShares QQQ ETF from 1999 to 2010.
The authors evaluated the impact of collar strategies against ETFs across a wide range of asset classes such as equities, commodity, fixed income, currency and real estate, based on a set of rules where a six-month put option is purchased and consecutive one-month calls are written. While Australian dollar and Japanese yen currency ETFs, two bond ETFs and Nasdaq and gold ETFs outperformed the collars, the strategy outperformed other ETFs across asset classes while providing significant risk protection.
Mr. Gocke said ETFs that were negatively correlated to assets that plummeted in the financial crisis performed better than those collar strategies.
A 2% out-of-the-money equity collar strategy returned more than 4.5% annually during the study period compared with -2.1% annually for the State Street Global Advisors' SPDR S&P 500 ETF, with less than half the risk as measured by standard deviation, according to the research.
When significant fear hit investors in March 2009 as the markets bottomed out, it was time to establish a new position, Mr. Gocke said. A collar strategy would have reduced the psychological fear so investors had confidence to buy stocks for long positions, he added. Investors should have been thinking, “This is one of the ways that I can get long if I have protection that the world is not going to end,” he said.
The analysis shows with respect to total returns, that collar strategies tend to outperform when drawdowns are more aggressive and underperform in times of extreme run-ups.
“If you believe the market is going straight up, you don't want to cap gains and you don't need downside protection,” Mr. Gocke said.