Stock Option Collar Strategy
Whether you’re looking to smooth out dips in the market, or have just a few short years to retire, a sound investment strategy may include what is known as a “collar.” This simple strategy has been deployed by hedge funds, pensions, and other institutions with great success. In fact, a recent study found it to be more successful than buy-and-hold investing over the past 10 years.
Stock Option Collars
A collar is created by buying shares in a company, as well as protective puts, and selling covered calls. The name comes from the differing prices at which you buy and sell, ultimately creating a sort of price collar around the chart.
Why it Works
The stock option collar is particularly effective over the long term because you’re holding 3 different positions, one short, one long and one practically sideways. (puts, pure stock, covered calls) The idea is that if a stock rises, the puts will lose value, the way out of the money covered calls will generate an income, and the pure stock will rise in value.
The Beauty of Stock Options
Stock options complete the system. Due to the fact that a stock option cannot drop more than its value, and the fact they can run for several hundred percentage points, they make an excellent player for any hedging strategy. Should your stock dip like crazy, your put options will only allow you to lose the difference between the strike price and the current value of the stock. As such, all you really have to lose is the premium, which is often 2-3% of the stock’s price depending on the expiration, not too shabby if I do say so myself. What you have to gain is the appreciation of the plain old stock, and the income from the covered calls.
The Numbers Behind the Practice
A recent study found that in a 10 year period, the PowerShares QQQ ETF lost 3.5% per year while the options strategy generated a 9.26% return. The difference there is staggering, however we must also consider that during bull markets, the collar would underperform, but only by the difference of the value of the stock option. Which, of course, would be larger in short term trades and smaller over the long term.
What a strategy? This is the type idea any reasonable investor can use to bullet prove himself against any unexpected loss.
Kudos to you, and I look forward to read more strategies from you.