Options-based strategies to reduce risk and boost relative performance in a down market are not new. This study, though, covers a 10-year period from March 1999 to May 2009, including the current crisis and the technology boom and bust. According to the study, which measured the differences in risk and returns among portfolios invested in the PowerShares QQQ ETF (QQQQ), using a buy-and-hold strategy, versus one that used a passive approach adding call and put options using "set rules" for the options collar on the QQQQ, and one that used an active collar strategy on the call and put QQQQ options.
Over 122 months, the maximum drawdown, or loss in a peak-to-trough period, for the buy-and-hold strategy was (-81.08%). By using the passive-collar approach with the QQQQ options, that drawdown was greatly reduced to (-17.90%). The active-collar strategy outperformed the buy-and-hold regarding the max drawdown as well, at (-21.73%).
Standard deviation (annualized for the 10-year period) was also lower in both the passive- and active-collar strategies over plain buy-and-hold: 30% standard deviation for the buy-and-hold strategy, versus 10.98% and 11.44%, respectively, for the passive- and active-collar strategies.
The study was conducted by Edward Szado, who is a doctoral candidate and research analyst at the Isenberg School of Management's Center for International Securities and Derivatives Markets (CISDM) at the University of Massachusetts, and Professor of Finance and Director of CISDM Thomas Schneeweis, with research assistance from the OIC.
Comments? Please send them to firstname.lastname@example.org. Kate McBride is editor in chief of Wealth Manager and a member of The Committee for the Fiduciary Standard.