Loosening Your Collar:Alternative Implementations of QQQ Collars

Abstract

The credit crisis and the associated decline in equity markets has rekindled new interest in option-based equity collars and in protective strategies in general. This article considers the performance of passive and active implementations of the collar strategy on the QQQ ETF as well as on a sample small-cap equity mutual fund. As expected, the results of the analysis show that a passive collar is most effective (relative to a long underlying position) in declining markets and less effective in rising markets. This article also considers a more active implementation of the collar strategy. Rather than simply applying a set of fixed rules as for the passive collar, in the active collar adjusted strategy, the authors apply a set of rules that adapt the collar to varying economic and market conditions. This approach is similar to applying a set of tactical asset allocation rules to a set of investments. There are of course an unlimited number of conditioning factors that can be used to determine the strategy implementation. For purposes of presentation, this article combines three conditioning factors that have been suggested in academic literature (momentum, volatility, and a compound macroeconomic factor (unemployment and business cycle)) to generate a dynamic collar adjusted trading strategy. For the period of analysis, the active collar adjustment strategy tends to outperform the passive collar. Judgments as to the particular benefits of the passive and active collar strategies are, of course, dependent on the risk tolerance of the individual investor.