Does Buying a Collar Option Spread Outperform Buying the Underlying?

10/20/2009 12:01 am EST


Mark Longo


We've examined the Options Industry Council's collar studies several times now. The purpose of these studies is to compare the returns of QQQQ collar strategies with the performance of the underlying outright.

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 six-month QQQQ put
  • Short front month QQQQ call

Past studies have shown that owning the QQQQ, hedging it with a six-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. Thankfully, the OIC decided to correct that omission in its latest study. 

The Latest Study

The OIC's latest collar study, entitled  “Loosening Your Collar: Alternative Implementations of QQQ Collars" addresses these shortcomings by implementing both a passive AND an active collar strategy.

Describing the many subtle differences between these two strategies would fill most of this column. Instead, I encourage Options Insider users to read the studyto determine for themselves if this latest study is applicable to their trading style.

Figure 1

The chart below displays the performance of the active and passive collar strategies over the ten-year study period:

Click to Enlarge

A few key findings from the latest study:

1. Both collar strategies generated superior returns over the ten-year time period when compared to owning the index outright.

2. The collar strategy also reduced the overall risk of the QQQQ portfolio by 65%.

3. The active collar strategy, which was also implemented on a small cap mutual fund, generated returns that were four times greater than the fund's returns with only one-third the standard deviation.

4. Over the ten-year period, the passive collar strategy returned 150%, while the QQQQ lost a third of its total value.

5. Over the same period, the active collar strategy outperformed both the QQQQ and the passive strategy, returning over 200%.

By Mark Longo of


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