Collaring the Cube: Protection Options for a QQQ ETF Portfolio

Abstract

This article assesses the effectiveness of a long collar as a protective strategy. We examine the risk/return characteristics of a passive collar strategy on the Powershares QQQ trust exchange traded fund (Ticker: QQQQ) from March 1999 to March 2008 and find that, over this time period, a 6-month put/1-month call collar provides far superior returns to the buy and hold QQQ strategy at about 1/3 of the volatility. Since returns from protective strategies are not normally distributed, we use both Leland alpha and the Stutzer index to measure risk-adjusted performance. In the analysis we consider a number of implementations of a long collar strategy, where for each strategy the impact of bid/ask spreads on the strategy's performance are taken into account. We vary the moneyness of the puts and calls as well as the time to maturity of the puts to create a total of 27 different implementations, and create indices to represent the returns to each of these collar implementations. To examine the collar's performance in different market environments, the time period is further segmented into two sub-periods, an early period which is generally favorable to the collar and a later period which is clearly unfavorable to a collar strategy. Most implementations significantly outperform the QQQ in the overall period, as well as in the favorable period. All of the implementations under perform the QQQ in the unfavorable (to the collar) period. However, all of the implementations of the collar exhibit lower risk than the buy and hold QQQ in all of the periods. The magnitude of the risk reduction of the collar is quite impressive.

Keywords: collar, options, qqq, qqqq, etf, strategy, portfolio, protection, insurance, trading, option, exchange, traded, fund, funds

JEL Classification: G11, G14, G23, G24, G10, G20, F21, E44, E32