We've examined the Options Industry Council's collar studies several times now (see
Trading Collars On The QQQQ as well as
Options Insider Radio Episode 17 for more information on past studies).
The purpose of these studies is to compare the returns of QQQQ collar strategies with the performance of the underlying outright (If you're confused about collar strategies, then read
How To Hedge Your Stock Positions Using Collars and
How To Hedge Your Stock Positions Using Collars - Part Two for more information on collars).
The OIC just released the findings from its latest collar study. The results reinforce the message that collars can play an important role in an equity portfolio. After all, downside protection is critical in any portfolio.
Unfortunately, far too many equity investors learned that lesson the hard way over the past year. Collars provide that crucial downside protection while still allowing investors to participate in some of the upside of their portfolio.
The Basic Components
The collar positions analyzed in the latest study have three basic components:
- Long QQQQ Underlying
- Long 6-month QQQQ put
- Short front month QQQQ call
Past studies have shown that owning the QQQQ, hedging it with a 6-month put and then writing consecutive front month calls generated better returns than owning the index outright. These returns were especially impressive when viewed on a risk-adjusted basis.
The problem with the previous studies is that they are extremely rigid in their implementation. This rigid implementation is suitable for the world of academia, where consistency is necessary to produce reliable data points. However, it doesn't reflect the conditions that most investors encounter in the real world.
Most option traders actively manage their collar positions to respond to current market conditions. They may write an ATM call one month only to follow it up with a 5% OTM call the subsequent month. This type of active management can dramatically impact the returns on a portfolio. But it was beyond the scope of the previous studies.
