From the February 01, 2010 issue of Futures Magazine • Subscribe!

How collar strategy can protect your portfolio

The credit crisis has rekindled interest in collars and protective strategies in general, and for good reason. In 2008-09, the PowerShares QQQ exchange-traded fund (ETF) experienced a drawdown of roughly 50% from peak to trough. Even diversification, which many rely on to be a strong guard against portfolio-wide losses, didn’t protect as expected.

Many asset classes that are generally considered effective equity diversifiers also faced significant losses. Correlations of most asset classes with broad equity indexes tended to be significantly higher in 2007 and 2008 than in previous years, negating much of the expected benefits of diversification. This type of contagion across asset classes suggests that in times of major systemic stress, direct hedges through protective options strategies provide equity portfolios with more benefits than standard diversification programs.

A new study has found that a long protective collar strategy using six-month put purchases and consecutive one-month call writes earned far superior returns compared to a simple buy-and-hold strategy, while reducing risk by almost 65%. The study (“Loosening Your Collar: Alternative Implementations of QQQ Collars”) was conducted by Edward Szado and Thomas Schneeweis at the Isenberg School of Management’s Center for International Securities and Derivatives Markets at the University of Massachusetts.

Szado and Schneeweis evaluated more than 10 years of data on the PowerShares QQQ exchange-traded fund (Ticker: QQQQ) and its associated options. They also extended the analysis to a more active implementation of the strategy. While the passive collar used a constant set of fixed rules, the active collar used rules that adapt the collar to changing macroeconomic variables and market conditions. The active collar implementation generated higher returns than the passive implementation, while volatility was only slightly higher. Over the 122-month study period, the passive collar returned almost 150%, while the QQQ lost one-third of its value. The active collar outperformed both strategies and returned more than 200% (see “Active or passive”).

Page 1 of 3 >>
comments powered by Disqus