CBOE Collar Index Revisited

Six weeks ago, I discussed the CBOE Collar Index.  There are many possible indexes that the CBOE could have chosen to create.  They made a reasonable choice: the CBOE S&P 500 95-110 Collar Index.


That index creates a collar by buying a put that has a strike price nearest to being 95% of the value of the index, (or 5% out of the money) and selling a call option that is 110% the value of the index (or 10% OTM).  This works for many investors because they prefer writing OTM calls on a stock portfolio.

I was hoping to see the CBOE S&P 500 95-100 Collar Index (the call written is ATM) to allow a direct comparison with the BXM, the CBOE Buy-Write Index.  I've been posting comments on a bunch of personal finance blogs whenever I felt that such a comment was appropriate.  Those comments recommend adopting the collar strategy, instead of relying on asset allocation methods to protect portfolio value.

Alas, the 95-110 collar is costly, and significantly under-performs both the S&P 500 and BXM – most of the time.  When the markets fall however, the Collar Index (CLL) performs very well.  Convincing passive investors to consider learning to use collars is not an easy task in itself, but it would be easier if the CBOE's chosen collar index performed better.  Hence my desire to see the CLL index based on collecting the additional option premium available by selling ATM calls, rather than 10% OTM calls.

I'm hoping the CBOE will eventually publish the 95-100 Collar Index.  It would provide valuable information by telling investors the cost of protecting a BXM portfolio with 5% OTM puts.


8 Responses to CBOE Collar Index Revisited

  1. Mike S. 09/02/2009 at 10:52 AM #

    Mark, I have been studying the covered call option and started looking to see if any of my stocks would be a good fit. I found one called Blackboard (BBBB). I will list the details and ask if my interpretation is correct: I own 100 shares at 27.53 = 2753. Oct option, in the money strike price 22.50 Bid 11.30 =1130 premium.
    Current price 34.02. Morning Star list FV at 38. Stock has been in 28 to 34 zone. Does not seem to move toward its est FV of 38.
    If stock does not go down to Strike price I keep 1130 premium and write another call.
    If stock does go to strike: sell at 22.50 x 100 = 2250 plus prem 1130 = 3380
    3380 – 2753 (my original cost) = 627 gain. Are my figures correct? Thank you.

  2. Mark Wolfinger 09/02/2009 at 1:21 PM #

    1) The estimated FV is just that: someone’s guess a to what this company will be worth. THAT NUMBER IS A PIECE OF GARBAGE. Ignore it.
    2) You are confused.
    3) If the stock does not go down to 22.50, the call option will remain in the money and the option owner will exercsie the option when October expiration arrives.
    You will be obligated to sell your shares at the strike price. You will no longer own any shares and you will NOT be able to write another call.
    4) You are confusisng puts and calls. If you sell an Oct 22.50 PUT option and the stock does not decline below 22.50, then the PUT option will expire worthless and you will be able to write another PUT option. But these put options are worthless and you cannot et anything for selling them. Don’t do it.
    Obviously, when you sell a put, you are NOT selling a covered call.
    5) This is your biggest mistake: Be very careful here. Yes, you would have a profit of $627. But that is 100% immaterial. Right now, you have a larger profit and all your trade idea can do for you is allow you to earn less money. It’s a guaranteed loss of cash.
    The stock is currently worth $34.02. Why would you sell the 22.50 call option for far less than it is worth? Why collect $3380 at expiration when you can collect $3402 now?
    An in the money option has an intrinsic value. That intrinsic value equals the stock price minus the strike price. In this example, that is 34.02 – 22.50, or 11.52. Selling the option at any price below 11.52 is absurd. Do not do it. It is throwing money in the garbage. When selling this option, the profit potential is the amount above the intrinsic value. In this example, that’s a negative number. Thus, your best profit potential is a loss.
    And on top of throwing away money, you have to pay a commisson to sell the call option. And you would have to wait until October to collect $3,380 when you can collect $3402 today.
    It is mandatory that you grasp the concept of intrinsic value and not selling options at a lower price.
    6) You have absolutely zero to gain by selling this call option It is not a viable candidtae for writiing covered calls. Please do not make this trade.
    If you do not understand, please comment again. This is a very basic tenet of using options. If you don’t understand this concoept, take it as a warning that there are other things you don’t understand. Please be careful.

  3. RS 09/02/2009 at 1:43 PM #

    I would very much like to see the result, if you ever get it, for the 95-100 Collar Index. My brother owns and runs a hedge-fund, and his strategy is exactly that – selling ATM calls and buying slightly OTM puts. He does make some adjustments, however, but still the result should somewhat correlate with the 95-100 Collar Index. Thanks.

  4. Mark Wolfinger 09/02/2009 at 2:22 PM #

    I will write about it immediately, if the data is ever made available.
    It can’t hurt if you can find someone at the CBOE and make the request.

  5. Henry 09/02/2009 at 10:39 PM #

    Hi Mark,
    I am not sure if you read my response @ http://www.wheredoesallmymoneygo.com/is-warren-buffett-managing-your-money/ , but here it is:
    Thank you for your response.
    I highly recommend reading the entire study. It should not take more than 15 minutes.
    Regarding to “asset allocation”, the study’s theoretical portfolio has 5 asset classes instead of just one. Since the different asset classes move slightly different in the bull markets, one can benefit from the covariance. Using SMA200 to exit the market before the bear market crashes, one would not experience simultaneous correction of the multiple asset classes, where the covariance is 1. By combining asset allocation (multiple asset classes resulting in lower volatility of the entire portfolio) and trend-line analysis (do not long assets during severe bear markets), one can benefit the best from both worlds.
    However, SMA200 may not be sensitive enough for reentry at times. Matt Stiles from futronomics.blogspot.com told me that I need to use SMA50 or SMA20 as entry points or stop loss if the SMA200 is very far away from the present price. This removes the concern that
    SMA200 provides a slow re-entry point into an emerging bull market (cyclical or secular). Again, neither SMA50 or SMA200 is perfect and even combined, they cannot create a perfect system. I am trying to figure out how to use SMA50 and SMA200 together systematically.
    Actually, I am not able to use collars at this point, because I am not allowed to sell covered calls. However, I have looked into collars seriously. I hold VWO. According to Yahoo Finance, DEC 09 37 Call has a bid of 1.45 and an ask of 1.75 and DEC 09 32 Put has a bid of 1.65 and an ask of 1.95. Assume that I can sell DEC 09 37 Call at 1.60 and buy DEC 09 32 Put at 1.80, I would pay .20 for insurance. In this scenario, it does not seem to be too bad at all and I would consider it if I am able to write covered calls.
    Since I am not able to use covered calls, I am using SMA50 instead as a stop loss. SMA50 right now tells me that I need to sell @ 33.32 as a stop loss. That is what I am going to use. So most likely, I will be selling VWO @ 32 or 32.5 if VWO does reach to that point just like using DEC 09 32 Put. Using the SMA50 is great for me since I cannot write covered calls, I do not loose the upside after VWO reaching 37, and I do not need to pay .20 for insurance.
    I have to admit using SMA50 and SMA200 can be stressful especially at the turning points and mastering behavior finance is required when using SMA50 and SMA200.
    By using SMA50 and SMA200, I am trying to do what I call “Adjusted Buy and Hold”. I am long asset classes in a bull market and neutral or short asset classes in a bear market. A traditional buy and hold is long asset classes no matter what the situation. With “Adjusted Buy & Hold”, I think can bear the 10% to 20% correction in the portfolio vs the 50%+ corrections that traditional buy and hold strategy experiences. However, the strategy that I am using cannot deliver exceptional returns (15% to 20% annual returns) without leverage and other alpha creating strategies. In conclusion, I think using SMA50 and SMA200 with ETFs satisfies Ben Graham’s First Principle of Investing: Investing requires the protection of principle and adequate returns.

  6. Mark Wolfinger 09/03/2009 at 8:07 AM #

    1) Sorry to say I had not seen your last response.
    2) For readers here: SMA = simple moving average.
    3)Earler you had mentioned that ‘commissions are what counts’ in Canada. It seems to me that’s all that matters to far too many professionals here in The States also. If an investor has an advisor who thinks that way, he/she is already in trouble.
    4) I have no problem with using SMA or any other technical analysis method to time the market. But, as you know, few – if any – professionals advocate that methodology. They would rather see clients invested at all times – and yes, in various asset classes. The academic stuies all tell us that trying to beat the market is a foolish, time-wasting endeavor. But that does not make it true. If you can do it, if you are taking the time to do research, learn and plan – then more power to you. I urge you to take advantage of those TA tools.
    5) You and I agree that asset allocation works during bull markets. By ‘works’ I mean that the results are ok. But, I have come to believe – on anecdotal evidence, not a true academic study – that anything works during a bull market. Innocent investors, who trust their advisors, accept the returns because the are ‘good’ returns. Thye have no idea whether the returns are ‘good enough’ or whether their advisors charge fees for underperforming the markets.
    My problem with asset allocation as the PRIMARY method for controlling risk is that I am NOT a believer that it works during bear markets in today’s world. My (unproven) belief is that too many undisciplined people now depend on asset allocation. If the stock market heads south – these investors will panic and sell all assets. If that is true (as I say, an opinion, and unproved) then all assets will fall and provide inadequate protection.
    6) I don’t say that collars are perfect either. What I like about that option strategy is the guarantee that losses can be strictly limited to a predetermined level. And sacrificing the large upside is just too much for many to accept. But I can accept it.
    7) The problem of not being able to write covered calls ought to be solvable. Can’t you find a broker in Canada who allows that (and who also has reasonable rates)? It’s considered to be a very elementary strategy here, and few are denied permission.
    8) The data from the CBOE Collar Index (see first link in the blog post to which you commented) tells me that the specific collar chosen by the CBOE is just too costly for most investors. But, I firmly believe (without the data to back it up) that the CBOE S&P 500 95-100 Collar Index (which does not yet exist) would show that writing ATM calls (instead of 10% OTM calls) improves performance sufficiently to make it a viable alternative for many.
    The bottom line is that if you can use TA to successfully time the market, you don’t have to worry too much about taking big losses. Your major worry would be that the SMA can get you in late and out late, and occasionally provide a whipsaw.
    9) ‘Adequate’ returns is of course determined by the opinion of the invesstor. But if you can produce 15 to 20% on a consistent basis when not in a bear market, then you are going to do fine over the long term. That suggests to me that collars are not for you. But I cannot outperform the markets without using options. I cannot pick winning stocks. So I don’t try. Graham and Buffett notwithstanding.
    You appear to have found a method that works for you.

  7. Mike S. 09/03/2009 at 12:29 PM #

    Thanks for your quick answer to my question. Thanks for the lesson. I jumped the gun by looking to see if any of my stocks had a fit with a covered call before I had studied the section on intrinsic value. Be assured I am very conservative in my investing. I would not attempt a live trade until I felt comfortable with several paper trades. I probably will read your book or sections of it several times. Again thank you for your help.

  8. Mark Wolfinger 09/03/2009 at 12:37 PM #

    My pleasure.
    I’m glad to learn that you have your head on straight.