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Can You Beat the Market? Part V. Collars Outperform Buy and Hold

Parts: one, two, three, four

University of Massachusetts Professor Schneeweis and doctoral student Szado conducted a study, sponsored in part by the Options Industry Council (OIC).  The results are first being announced today, 9/23/2009, in a paper entitled: "Loosening Your Collar: Alternative Implementations of QQQ Collars."

Using 10 years of data, the study compared the performance of QQQQ, the PowerShares exchange traded fund when collared and when unhedged (owning QQQQ only, with no options).  As with the CBOE S&P 500 CLL 95-100 Collar Index, this study involved the purchase of 6-month puts and the consecutive sale of one-month call options. This time both the puts and calls were 2% OTM when traded.

[NOTE:  If the same nomenclature were used for this collar as for the CBOE collar, it would be called the OIC PowerShares 100, 98-102 Collar Index].

The study included two different collars: passive (with a set of fixed rules) and active (the rules vary according to changing economic conditions).

The study shows that the collared QQQQ portfolio significantly outperformed a portfolio that simply owned QQQQ from April 1999 through May 2009.  And if that's not enough of an eye-opener, risk was reduced by 65% over the 122 month study.

These results are spectacular, especially when compared with the performance of the CLL 95-110 Collar Index.  I'll comment on that later, but for now, let's concentrate on the findings.


Author's Conclusions

The 6-month put purchase is better than buying either one- or 3-month puts.

Active collar more effective than passive.  But, this is not the place to be concerned with the active collar.  The original paper can be accessed for that information.  UPDATED:  link to that paper.

The authors state that the collar was less effective during the steady up years of 2002 to 2007.  That's as expected.


My comments:

The graph says it all.  The QQQQ got hammered during the bursting of the technology bubble, and that's understandable because QQQQ consists of the 100 largest capitalized, non-financial stocks that trade in the NASDAQ market.  That means this ETF was loaded with technology stocks.

But, something bothers me – and I'm publishing this post before discovering the answer.  Collars are slightly bullish strategies. If you recall from previous discussions, a collar is equivalent to selling a put spread.  These positions are protected against large losses, but how did the collared QQQQ increase in value as the underlying asset was plunging in 2001? 

Is it possible that the premium collected by selling the call was so much higher than the premium paid for the put that it offset losses in the decline of the ETF?  That's just doesn't sound reasonable.  When markets are falling, IV is high, but is skewed so that lower strike prices (the puts bought) is higher than that of higher strike prices (the calls sold).

The only way I can see the collars increasing in value occurs if the strategy is not a true collar but includes more than one put per 100 shares of QQQQ.  Yet, the collar in this paper is defined as one put and one call per each 100 share.  I'll go through the details when available, and report back.  But right now, I find these results very unusual.

Addendum @ 6 minutes later.  Apparently when puts were significantly ITM, there was no longer any downside risk.  Thus, the sale of 2% OTM call options resulted in a profit month after month, as the calls expired worthless in a declining market.  These feels 'wrong' to me.  It's essentially selling (almost) naked calls.  Who would do that in the real world?


These results are very unexpected.  The normal expectation for collars is that they will do an excellent job and protect your portfolio when the market declines.  But, to gain the benefits of that downside protection, the collar owner must accept a limit on upside profits.

And that's the problem.  During the  years of this study, the market was down.  The annualized return for QQQQ over the 122 months of this study is -3.57%, and that's a significant decline.  In other words, there was no upside to sacrifice.  But there was plenty of downside – specifically the bursting of the technology bubble in 2000 – 2001 and the 2008- early 2009 bear market.  Under these conditions, collars always perform well.

Don't misunderstand.  As someone who believes strongly that millions of individual investors should seriously consider using collars on all, or part, of their holdings, I like the results of this study.  But I have no plans to use it out of context.  I want to see how this strategy worked from 1995 through 1998 and May 2009 through the present time.  I want to see the data for this strategy at its worst, not only at its best.  Then we would all be able to see just how well collars perform when compared with buy and hold.  I know this study was performed in academia, and that the numbers can be trusted, but I wonder whether the time period chosen was cherry-picked to produce these outstanding results.  More data please.

From the performance of the CLL 95-110 Collar index (see part IV), we can see severe underperformance for the collar strategy in the most bullish years.  Yet, collars were very valuable during bear markets.  Overall, the performance of this specific collar was disappointing. 

But, in defense of collars, the CBOE produced a collar index that is not as valuable as they might have chosen.  Writing call options that are 10% OTM may be suitable to the bullish investor, but to someone who wants to use collars for both capital gains and protection, I believe the more useful Index is the 95-100 CLL Index, which includes the sale of ATM calls.  I urge the CBOE to publish the CBOE S&P 500 95-100 collar index, which would allow a direct comparison with its BXM (Buy-Write Index).  

There is a lot of data, but it's costly and time consuming to put it all together.  And there are so many possible collars that it's difficult to know which to produce.  But I would love to see the CBOE continue to produce indexes that pull all the data together.  And I'm encouraged that the OIC took part in this study, and I encourage them to support additional studies.

Bottom Line: This paper is very welcome and shows that collars are not always too expensive to pay for themselves and are capable of producing market out-performing returns.  I just wish we had more data.


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