UofMass Study: Option Collar Strategies Deliver Better Performance With Less Risk

As reported by Pension&Investments Magazine, a newly-published research report from the University of Massachussetts has found options-based collar strategies would have outperformed the market in most asset classes, while providing drastically reduced risk leading up to the 2008 financial crisis, AND as well, throughout the subsequent recovery.

“The contagion across asset classes during the financial crisis suggests that protective options-based investment strategies, such as collars, when implemented on a wide range of asset classes, could provide portfolios with greater downside risk protection than standard multi-asset diversification programs,” according to a summary release of the report issued by the Options Industry Council, which helped sponsor the research by Edward Szado and Thomas Schneewies. Mr. Szado is a research analyst and Mr. Schneewies a professor of finance, Isenberg School of Management, University of Massachusetts.

The research covers the 55 months from June 2007 to Dec. 31, 2011, and expands on a 2010 paper that studied the effects of a collar strategy against the PowerShares QQQ ETF from 1999 to 2010.

The authors evaluated the impact of collar strategies against ETFs across a wide range of asset classes such as equities, commodity, fixed income, currency and real estate, based on a set of rules where a six-month put option is purchased and consecutive one-month calls are written. While Australian dollar and Japanese yen currency ETFs, two bond ETFs and Nasdaq and gold ETFs outperformed the collars, the strategy outperformed other ETFs across asset classes while providing significant risk protection.

A 2% out-of-the-money equity collar strategy returned more than 4.5% annually during the study period compared with -2.1% annually for the State Street Global Advisors‘ SPDR S&P 500 ETF, with less than half the risk as measured by standard deviation, according to the research.

The analysis shows with respect to total returns, that collar strategies tend to outperform when drawdowns are more aggressive and underperform in times of extreme run-ups.

Noted David Beth, a senior principal of option and ETF specialist firm WallachBeth Capital, “Having spent most of my career advocating the use of both very simple and/or somewhat advanced option-centric strategies within the framework of pension and other institutional portfolios, the most important take-away from the study is not the focus on collar strategies per se, but the obvious increasing attention on the part of fiduciaries to better understand and make better use of exchange-listed option products. ”

Added Beth, “There’s always been a misconception that options are primarily used by hedge funds and other risk-taking profiles, but the fact has always been these products are purposefully designed to enhance Alpha and enable conservative-minded institutional fund managers to sleep better at night knowing they are performing their fiduciary obligations.”