A collar is an options strategy meant to lock in profits and reduce risk. It makes sense when a trader has a large gain in a stock that he has held for 11 months and thinks it is going down but wants the long term capital gain instead of a short term gain. Some will use it if they are concerned about a binary event such as an earnings announcement or a possible "Black Swan" scenario. Others claim it is a wise strategy to use in conjunction with a long stock position. The head of our research team, Michael Rechenthin, Ph.D., aka Dr. Data, had his doubts.
The CBOE publishes data for two different collar indices, the S&P 500 95-110 Collar and the S&P 500 Zero-Cost Put Spread Collar. How do these strategies compare to the S&P 500 with dividends or a short at-the-money (ATM) Put?
Mike began by describing what exactly each of these collars were and how they worked. The S&P 500 95-110 Collar is Long S&P 500, buying a 5% out-of-the-money (OTM) put that expires quarterly and selling a 10% OTM Call that expires monthly. This trade is usually put on for a debit because of the expense of the OTM Put. The S&P 500 Zero-Cost Put Spread consists of Long the S&P 500 Long the OTM Put spread (2.5%, 5% OTM) and selling the OTM Call to cover the cost of the Put spread.
Mike used a P/L graph of each position to enhance his explanation, detailing where profits and losses were capped for the 95-110 collar and where profits were capped on Zero-Cost Put Spread but how a large enough down move would result in losses. A graph of running profits and losses was used to show how much better the S&P 500 performed (with dividends included) compared to either collar. Another graph included an at-the-money (ATM) short Put as an alternative. The S&P 500 with dividends clearly beat the collar strategies but the short ATM Put beat the long stock strategy.
A table comparing the four strategies measured them for average annual returns, the Standard Deviation (SD) of those returns and the percentage of weeks profitable. The short ATM Put clearly performed the best overall. Two tables contained the annual returns for each strategy. The first table covered the period from 2000 to 2007 and the second from 2008 to 2016. The collars underperformed the S&P 500 with dividends while the short ATM Put outperformed. Collars just don’t make sense as a long-term strategy.
Watch this segment of Skinny on Options Data Science with Tom Sosnoff Tony Battista and tastytrade’s research team leader Michael Rechenthin, Ph.D. for all the key takeaways on Dr Data’s analysis of these two collar strategies compared to the S&P 500 (with dividends) and his suggested strategy of a short at-the-money Put.
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