From the August 01, 2012 issue of Futures Magazine • Subscribe!

Collaring multiple-asset ETFs to manage tail risk

Trading approach

In their book, Szado and Schneeweis evaluated the impact of collar strategies across a wide range of asset classes based on a set of trading rules (see “Cross-market analysis,” below).

For each of the ETFs, the study analyzes an array of strike prices with defined amounts of OTM values where a six-month put is purchased and consecutive one-month calls are written. At the close on the day before the Saturday expiration of the calls, and depending on the particular passive implementation, the initial amounts the calls and puts were out-of-the-money were set at: 25%, 10%, 5% or 2% or at-the-money (ATM).

At expiration, the calls were settled at intrinsic value, and new one-month calls with the specified amount of OTM were sold. The longer-term put is held for another month. Once the six-month put expires, it is settled at intrinsic value and again rolled into new puts and calls with the specified amount of OTM and time to expiration. 

A rule was created to avoid circumstances in which the underlying prices declined significantly and new calls then would have been written at lower (crossed) strike prices than the existing deep in-the-money (ITM) puts. In these cases, long put and long underlying positions would counteract each other and the new call essentially would be written naked.

Because writing naked calls is inconsistent with the risk-reduction purpose of the collar strategy, Szado and Schneeweis implemented a rule to roll the puts to the strategy’s target amount of OTM and maturity based on the current underlying price on the day the new short call position was initiated. The put sale was rolled at the mid-point between the bid and ask, and the new put was purchased at the ask price. All other executions in the study include transaction costs by purchasing at the offer price and selling at the bid price.

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