Tag Archives | financial planners

More on Financial Planners and Collars


Great blog. As an advisor in a similar position to AH, I find this
blog extremely helpful when it comes to developing various options
platforms. This post was especially helpful as collars are the main
risk management strategy we hope to utilize.

Your answers have pretty
much confirmed my original ideas; however, I have the following

1. We have diversified portfolios that blend passive ETFs and different
active managers. As such, I was thinking that portfolio Betas
(relative to the S&P 500) should be used to determine strike prices
and the amount of options purchased/sold on the S&P index. For
instance, if a client has a Beta of .50 and wishes to lose no more than
15% a strike 30% below the current S&P level could be used before
the client would reach that 15% waterline.

Likewise, only half of the
portfolio would have to be used when determining how many S&P index
options to purchase. Ignoring the problems with Beta (I can't think of a
better way to hedge the portfolio), is that above assumption generally

2. Given the high cost of S&P index puts relative to calls and the
goal of collar (at least in our case) of downside protection, what is
the danger in buying puts 12 months out and rolling calls? The shorter
calls should allow to take greater advantage of positive Theta and
looking roughly at the math may turn out to cover the cost of the puts
(I realize there is no way to calculate this), while the longer dated
put would provide the desired hedge.

3. Does is make sense to actively manage the collar or just let the
strategy run its course? While there certainly are situations when one
might be more beneficial, is there a broad explanation? I was thinking
of selling the put if it is in the money and using the proceeds to by an
at the money put or rolling up calls on the upside.

4. Similar to the question above, does it make more sense to close the
position prior to expiration or let the options become exercised, if
Given the length of the questions, I understand if you can't get to
this. Regardless, thanks again for the very insightful blog and I look
forward to learning more from you in the future.



Thanks ZA,

Glad to hear this blog has been helpful.

1) If I understand correctly, you don't want to collar the specific positions you own, but prefer to buy puts and sell calls on SPX.  I'll assume that is correct.

Nothing wrong with doing that.  However, as far as your broker is concerned, this involves the sale of naked calls on the SPX.  Yes, you are covered for risk, but many brokers will not allow the sale of naked calls.  Period.  Those that do require large margin.

Do not allow this to be a limiting factor for you.  You can find a broker who will accommodate this strategy.  Of course, some clients may not want to change brokers, and you may not be able to adopt this methodology for them.

2) We tend not to use beta in the options world, and use the volatility of each ETF on its own. By owning funds of active managers (I hate the fees charged; I hope the returns justify those fees), you don't have such a volatility number and would have to calculate it – or use beta as being 'good enough.'

3) If you have a .50 beta portfolio, you are assuming a 15% move when SPX moves 30%.  If beta holds true to form, that is a reasonable expectation.  Just be aware that sometimes specific types of investments can become more (or less) volatile than one would expect and beta can change.

If you accept this limitation, using beta ought to be okay.  I'd like to avoid beta calculations, but it's also time consuming and costly (broker commissions) for your clients when you collar each investment individually. 

4) When choosing a strike price [30% OTM (out of the money) in your example], don't ignore the cost of the put when estimating the maximum loss.  Unless you plan to offset the cost of the puts by selling calls at approximately the same dollar amount.

That is a good way to choose which calls to sell – but it's a call that expires in the same month.

5) You ask about the risk of owning long term puts and selling monthly calls.

The long dated put does not provide the hedge you think it does. 

I recently posed a lengthy (2 part) description of that risk.  It is MUCH LARGER than expected.  And oddly, the downside risk is just as large as the upside risk.  This is NOT a good idea for your clients.

It may be a good idea for anyone who wants to 'play volatility' – but a customer should not be paying for trading advice from a planner.  He/she should be paying for planning advice.  Clients who are interested in setting a maximum risk level should NOT be doing as you suggest.

Yes, you can earn lots of extra dollars.  But this idea can lose bunches of money and is just not the right strategy for people who they to limit losses.  Please read that post.

Even if you decide to take this risk, you do NOT want to buy long term options when IV is high. You pay a lot for those puts and may get very poor prices for the shorter-term options. 

6) I do not believe it is correct to hedge half the portfolio. 

Assume a client has 100k, and you buy options that are 30% OTM.  If those are eventually exercised, the assumption is that a .50 beta portfolio would lose only 15k and not 30k.  That is he maximum.  You cannot buy fewer puts.

NOTE: SPX options settle in cash, so if exercised, you get some cash to offset losses beyond that (estimated) 15% loss.

7) In general you do not want to actively manage the collar.

But, that does not mean you should not take advantage of certain situations.  If for example, the market tanks and Iv moves higher, that may be a good time to do as you suggest.  Roll the put to a less expensive one, taking in cash and improving the upside.  Do keep in mind that this makes the downside worse – so the 15% maximum may be exceeded.  I'm not saying not to do it.  I am telling you to consider the new potential loss.  When markets are falling is when clients will not want to give up protection. 

It's a difficult decision.  You can earn a lot of extra dollars if you get lucky and make such an adjustment near the bottom.  That's why it's important to recognize just how much you are making the downside when making this trade.

The idea is to take out some cash – it's safer not to grab the maximum amount of cash from an adjustment.

You may also want to roll the call, but be careful not to roll too far.  That could hurt the upside.  Be certain the call still has a higher strike that the new put you own.

8)  If using SPX options, it doesn't matter if you exercise them.  These are settled in cash.  And as a reminder, these options are European style and cannot be exercised prior to expiration.

However, if you do trade ETF options for some clients, then it gets messy to exercise options and take a position in the underlying.  I would exit and roll as expiration day gets near to eliminate this inconvenience.

If you are assigned on calls, same situation.  No real problem, but it's better to avoid taking a position when you don't have to.  Just roll prior to expiration.  Pay attention to ex dividend date when trading SPY.

One more thing:  I know that many
investors find options complicated, but that is due to a lack of
understanding.  If you have clients who want to understand what you are
doing for them, please recommend The Rookie's Guide to Options.


Free e-book: Introduction to Options: The Basic Concepts

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Financial Planners and Collars

Hi Mark,

Clearly collars reduce downside risk. As a financial planner I'm
very interested in using them to help protect client portfolios. There
are some issues which I'd like your views on before treading this path

1) How close to the price of the underlying should the collar be
established? My own research indicates that the more volatile the
underlying and the further into the future the option position is
established, then the 'wider' the collar should be to maximize long term
returns. On the other hand, 'narrower' collars reign volatility in
further but appear to really hurt long term cumulative returns. How
wide should your collar be? Should it be skewed eg. 10% downside
protection and 20% upside ceiling?

2) This post is all about collar adjustments. As a planner, clients
with even medium account sizes can't afford to pay someone to
continually adjust collar positions, even less so if multiple
underlyings are held. Is a 'passive' collar strategy wise eg. 3, 6 or
even 12 months out?




The fact that you, as a financial planner, want to use conservative option strategies to help your clients is good news.  I have complained – on this blog and on other blogs wherever I could find them – about how financial planners have done immeasurable harm to their clients by remaining ignorant about options.

Let's begin with some general statements:

Each client has different needs, and as you would not recommend the same holdings to each client, so too, will you make slight modifications to the specific collar recommended.

Collars are going to underperform when the markets are strongly bullish.  That's the cost of owning insurance.  Be certain your client is willing to accept that fact and does not blame you for such under performance.

Collared portfolios perform extraordinarily well when markets tumble.  The greater the fall, the happier your clients will be for having taken your advice.  They will not make any money, but losses will be at acceptable levels.

Assuming you have reasonable clients, you should be able to explain that pluses and minuses when holding collars.

If the put and call expire in different months, you will earn extra money when the markets cooperate.  However, I believe they are too risky and voids the whole idea of owning a collar FOR PROTECTION in the first place.  Per the example offered by a commenter.  Mixed expiration collars are okay if you understand the extra risk involved.  That's not for a financial planner and his/her clients.

1) The first question is:  Which is more important to each client?  Is it the desire to earn as much as possible with low risk?  Or is it the preservation of capital, with the hope of earning a small return?

2) If preservation of capital is the name of the game, then it should be easy to choose the put strike price.  In a worst case scenario – and for this client that's a down market – how much is your client willing to lose over the time period covered by the collar?  If it's 10%, then buy a 10% OTM put.  If it's less, choose an appropriate put to buy.  With indexes there are always plenty of choices.  With individual stocks, it's more difficult to choose the appropriate put because there are far fewer offered.  There's a big difference between strikes of 30, 35, and 40.  It it were an index or ETF, there would be strikes every one point, giving you just the put you need.

3) If earning capital gains is the
objective, then I'd begin by choosing the call to sell because that caps
the upside.  Then perhaps it would be easiest to buy a put that costs
essentially the same as the premium collected from the call sale.  This is
the 'no-cost collar.'

Profits are the goal, but losses must be capped at some point.  You buy a put that is less expensive offers less protection against loss.  How much the client is willing to pay to own the collar will determine just which put to buy.

Keep in mind that paying a debit means the client will lose money when the market is steady to slightly higher.  That may not sit well.  Those zero cost collars don't always provide the best strike prices, but if the client does not understand the details of what you are doing for him/her, then you ought to adopt middle-of-the-road methods that offer the best protection you can afford to buy – given the circumstances.  The person who wants to sell calls that are 20% OTM is not going to be able to afford to spend much for put protection.  In fact, I'd suggest that if the client is that bullish, perhaps a collar is not the best choice.

If trading indexes or exchange traded funds (ETFs), you can assume they won't drop 30% overnight, but as we have seen, 50% in one year is not impossible, and owning puts is beneficial.

For this client, there is no easy way to pick the put strike price becasue protection is not the top priority.  Perhaps you can decide how much to pay for puts ad make the decision that way.  This would result in far less protection now, when markets are volatile (and everyone wants to own protection) and more protection when markets are calmer and option implied volatility is lower. 

4) If you follow the advice on choosing the put to own, and if you allow your pocketbook to determine how much to collect when selling the call, the first question becomes unimportant.  It just solves itself.

5) There is no reason to make a client trade more often than necessary.  I'd look to trade 12-month collars for clients who are not interested in active trading.  More than that, I'd encourage them to own SPY (or another broad-based index), unless you or they have displayed a talent for picking stocks that out-perfrom the market.  One ETF means only one collar trade at a time, rather than one per underlying stock.

6) Don't forget, it's not necessary to collar an entire portfolio.  Even 25% is better than none – when you want some safety.



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