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Passive Investing Protection with Options Collars

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This is a guest post written by Mark Wolfinger of the investing blog Options for Rookies. Mark grew up in Brooklyn and in an earlier life, earned a PhD (chemistry) from Northwestern. After several years as a research chemist, in Dec 1976 he moved to Chicago to trade options. Over the next 23 years, he was primarily a CBOE market maker, but also worked as a risk manager, and coached new traders. He left the CBOE in 2000 and began a career as an educator. He’s published three books and numerous magazine articles.

Mark recently authored The Rookie’s Guide to Options and he approached me with a novel guest post idea. You don’t normally associate options with passive investing but he is going to explain how you can use options, specifically collars, to protect yourself when passive investing.

Let’s begin by agreeing:

  • a) Passive investing beats active investing – for all but the few talented traders who consistently outperform the markets. Let’s also agree that none of us is a member of that elite group.
  • b) The rules: allocate assets, diversify, buy and hold, don’t panic by selling into market declines etc. These are the most commonly used methods to minimize investment risk. They are constantly repeated by journalists, bloggers, brokers, financial planners and financial advisors.

Should most of us follow this advice with confidence? Do we save a portion of each paycheck, invest passively, and confidently accept whatever happens?

I vote ‘no.’

I ask: Why own an investment portfolio that’s unprotected against loss? Why allow your financial security to be threatened by severe market declines? Sure, the market is likely to trend higher over the years, but why take that chance?

Today’s investors can do better. Times change: stock is the core holding of almost every prudent investor’s portfolio, yet only 100 years ago the idea of owning stock would have been considered lunacy. Today, new investment tools are available, and professional advisors ignore them. You can’t blame them for protecting themselves. Offering sound, but not universally accepted, advice that may result in lost money is an invitation to a lawsuit.

Where Options Fit In

Options were created as risk-reducing tools and can be used to protect your investment portfolio against significant loss. Consider a single option strategy – the collar. As passive investors, assume that the stock market portion of your portfolio consists of ETFs (please: do not buy 2X or 3X ETFs because they do not perform as advertised) that mimic the performance of specific broad based indexes, such as SPY (S&P 500) or IWM (Russell 2000).

Assume you own 100 shares of SPY, currently trading near 107. That investment is worth $10,700.

If you buy one SPY Oct 105 put, you get the right (that expires on the 3rd Friday of Oct) to sell 100 shares of SPY at 105 (the strike price), no matter how far SPY declines. Ignoring the cost of the put for now (it’s about $140), your losses are limited to $200 in this example (pay 107, sell 105). There’s nothing special about this put and you can buy a put with a different strike price or expiration date.

To complete the collar, sell one call option, which gives someone else the right to buy your SPY shares at the call’s strike price. You collect cash when selling the call – and you can easily arrange for this cash to offset the cost of the put, giving you the collar for approximately zero out of pocket cost.

If you elect to sell the SPY Oct 109 call, you accept the obligation to sell your shares at 109 – but only if the call owner chooses to exercise his/her rights. Obviously your maximum sale price (109) limits potential profits.

You can own this per collar for no cash (call priced a few pennies higher than the put). You are guaranteed that your position cannot lose more than $200 and that your profits cannot exceed $200 as long as the collar is in place.

Collars are flexible and provide alternatives:

  • a) To possibly make more money on a rally, sell calls with a higher strike price. The collar costs more because you collect less cash for the call.
  • b) If you prefer to pay less (or even collect cash) when establishing the collar, choose a call with a lower strike price.
  • c) Buy a put with a higher or lower strike price. That’s similar to changing the ‘deductible’ on an insurance policy.

Are collars for you? They’re not for everyone, but owing passive investments with no chance of incurring large losses, coupled with the opportunity to grow your account over the years – that works for me. The problem is that not everyone is willing to accept a limit on potential profits, nor is everyone willing to be a hands-on investor (trades can be made monthly, quarterly, annually). Don’t trust any financial advisor to makes these trades for you -at least not until collars are more widely recognized as tools for the Prudent Investor.

How well do collar perform compared with buy and hold? Recent data says better than expected.

{ 36 comments, please add your thoughts now! }

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36 Responses to “Passive Investing Protection with Options Collars”

  1. Chuck says:

    There’s no such thing as a free lunch.

    Anyone pushing options as a risk-free way to make money doesn’t get it. One way to make that mistake is to focus on the fact that you can limit your losses, while ignoring the fact that you’re limiting your gains, too.

    If you can find a way to make significant risk-adjusted gains over a passive portfolio, you are violating the Efficient Market Hypothesis. To date, the EMH has not been disproven, so you’d probably have some Nobel prize on your hands.

    Every strategy has a time period it does well. Scientifically and accurately backtesting a strategy is really really hard to do, and backtesting badly can drive you to all sorts of wrong conclusions.

    When you make any kind of trade on an exchange, whether a stock, ETF, option, etc…, you can be assured of getting the best-known fair price for that security before costs (both transaction and spread). The more trading you do, the more costs you incur, money goes to the dealers, but you don’t get any added value in the long term.

    The “costless collar” is kind of a fiction. Yes, it is costless in dollar terms, but the discount is in exchange for taking on risk. If that were not true, who would take the other end of that transaction??

    I’ve researched this pretty heavily, and I’ve often gotten the idea that I’ve found a foolproof way to “beat the system,” but the system is really good, and it knows how to beat you in every circumstance apart from buy and hold.

  2. Dylan says:

    While you acknowledge that there is a cost (limited upside) to this downside protection, I think the significance of that cost is not made clear in your illustration. If someone plans to be invested in the market for decades and has shares called away at below market price, they have little choice but to repurchase those shares at a price greater than what they sold at.

    While the same condition applies where you can shed shares in a market decline at a price above market and then buy them back at a lower market price, options are priced by a market that doesn’t want either buyers or sellers to have an unfair advantage over the other. So, you cannot reasonably expect one condition to occur disproportionately to the other. When you also consider the additional costs of buying or selling the contracts, they no longer become as efficient as you illustrated.

    • Dylan,

      I kept the discussion pretty simple.

      No one has to ‘sell below market price’ and then buy back at a higher price. I truly don’t know where you get that idea.

      But let’s still keep it simple. If the market slides, You own the put. Instead of exercising the put option and selling your shares, you can simply sell the puts, collect your profit on that put and consider that profit as the offset against the loss you are taking from owning the shares.

      The investments are not sold. The loss in the value of the stocks has been neutralized (ok, almost neutralized, depending on the size of the deductible). The calls expire worthless. And you have the same position and very limited losses.

      It is not that complicated. Now you can choose to buy another collar or do nothing when the market has fallen. But that’s market timing and I assume you would be against doing that. So would I, but it is a choice that the investor can make for him/herself.

      And if you are assigned on a call option and forced to sell your shares, nothing unexpected has been lost. Limiting profits is what you agreed to accept when buying the collar. When that reality comes true, so be it.

      But you don’t have to sit there and do nothing as the market rises. You do have the right to buy back the calls sold earlier – and open a new collar at a higher market price. Above your limited profit threshold, you take a loss when buying those calls.

      But that loss is offset by the gain in the value of your stocks. Thus, you have NOT lost money. You lost the opportunity to make money. Those are not the same thing. But it is the price you agreed to pay when the decision to buy the collar was made. This is NOT a bad thing. It’s a trade-off.

      If you are that bullish then use collars on a portion of your assets, or perhaps on none. But not everyone feels so bullish all the time.

      Collar buyers understand the risk. Profits are limited. Thus, if not willing to accept that, if you need capital gains more than you need protection against loss, then that’s fine. Collars are not for everyone.

      Sure it’s fine to point pout why the strategy is not for you, but why take the stretch that it’s not a good idea? It’s a valuable for many millions of investors – investors who are unaware that this portfolio protection is available.

      This has nothing to do with being invested for decades, unless you want to make the assumption that risk is unimportant and that you just know for certain that the markets will do what they have always done – and that’s rise over time. I am NOT saying you cannot do that. My opinion is that is an unwise choice, and I’m trying to educate others to the possibility of longer-term risk. Once educated, each investor gets to decide for him/herself whether all, part, or none of the portfolio should be protected with collars.

      I consider the cots of trading collars and consider them to be acceptable. I want protection against loss. I do not need to get rick quick in the market. I do not want to depend on years like the late 1990s to occur frequently. As a collar owner, I would do ok in those years. Just not ok enough for you.

      My need is to be protected. My need is to be conservative. If yours is to be aggressive, then, by all means, go for it.

      I assume the readership here trends toward youth and these conservative ideas may not ring true. But they will when you get older.

      • Dylan says:

        All I’ll say in response to you, Mark, is that you draw *a lot* of assumptions about my comment that just are not there. My point is that I think you understated the costs in your post and made the trade-off sound more efficient than than it actually is. You don’t have to agree me.

  3. 1) I am NOT pushing options as a risk free play. I am not pushing anything. I’m here to let readers know that there are modern methods for protecting the value of an investment portfolio.

    You get a guaranteed stop-loss in exchange for a limited upside. That is not exactly risk free. Yes, losses are strictly limited. That’s the benefit.

    The cost is sacrificing some upside potential.

    That’s called a trade-off. That’s called getting risk against loss in exchange for the risk that you will not participate in a big market rally.

    If that’s your definition of ‘risk free’ then it’s you who doesn’t get it.

    2) It is your opinion that EMH has not been disproven. There are many reputable economists who disagree. No, I cannot provide a list.

    What I can tell you is that as more and more people get involved with asset allocation, there are more people who are going to panic in a market slide. They will sell everything. To the extent that this decreases the value of other assets, it’s obvious hat asset allocation is not as reliable as it was when fewer people were aware of the benefits.

    But you miss the point. Intentionally, IMHO. No one is claiming that using collars will beat any specific strategy. But what collars do is guarantee that if the market crumbles you are protected. That’s not good for you? You are only interested in the upside? Fine – then collars are not for you.

    But plenty of people have assets worth protecting. Many others are willing to be very conservative. What’s wrong with that? Why do you tell people to ignore the safety that comes with conservative option strategies? Why do you want everyone to take more risk?

    Sure, you believe in the EMH myth, but that does not mean that everyone else has to put their life savings in jeopardy just because you don’t understand how options work – and the benefits that are available when using them.

    With all due respect, let me ask you this: If you thought at time that you found a way to ‘beat the system’ – understanding how illogical that is – why is your investment judgment worth anything? No one truly believe the system can be ‘beaten.’ What you can do is maximize risk of loss while participating.

    To me your whole theory is based on the idea that EMH is true and valuable, that there is no point in looking for guaranteed safety (no, not for free, but at a cost); that taking your chances with the old standard risk-reducing methods is good enough for you.

    Times change. If you choose not to progress, that’s truly your choice. You are not wrong – when making decisions for yourself. But you are here, on a public forum telling people that I don’t get it when it’s you who are living with blinders on. And enjoying it.

    And if you love buy and hold so much, what’s wrong with buy and hold – but protected with an insurance policy? Yes – for you it”s the limited profits. But who are you to suggest that others would not benefit by trading those potential profits for guaranteed protection?

  4. Mr Woody says:

    What is the difference within a collar and a vertical spread?
    The clear advantage of a vertical spread is that you don’t need to own the stocks (so that the leverage could be much higher) and you surely pay less in commission.

    • Mr Woody,

      The put vertical spread is equivalent to the collar. And those who understand how options work can go that route.

      As an introduction to options, I don’t believe that’s an appropriate path to take, It’s much easier to understand the collar when looking at the 3-legged variety.

      • Mr Woody says:

        I still think that the vertical spread is a better option. I could invest much less money and keep the rest in the bank to get the interest rate from them.

  5. Chuck says:

    Wow… just wow… “EMH myth,” “life savings in jeopardy,” “you don’t understand how options work,” ad nausem.

    What’s wrong with buy and hold with insurance? It’s that you get less expected return than buy and hold.

    Honestly, if you can’t handle the risk of stock investing, you shouldn’t be investing in stocks. You can collar, or you can invest in bonds. It’s old fashioned, but in risk-adjusted terms, you’re in the same ballpark as a collar, but you’re not having your money siphoned by the croupiers.

    How does Black-Scholes price an option? It takes the risk-free rate of return (a bond) then adds volatility and intrinsic value. When you collar, (assuming the costless collar) your call and put basically cancel out the other factors, and leave you with the risk-free rate (over the long term, that is. You still get to experience the volatility in the short term). Then you pay for the spread, and the commission cost on each transaction. Your risk-adjusted return is bad, because you’ve factored out the risk, but at the cost of return. You may not see it now because your model was back-tested with the data that we have. But we all know that “past performance does not guarantee future results.” I wouldn’t be surprised if the result of a rolling costless collar over time is a negative real return. In nominal terms, it might be deceptively alluring, but it’s basically a Rube Goldberg machine for losing buying power.

    • Chuck,

      Your life savings are not ‘in jeopardy.’ And I love how you put that in quotes. I assume you are trying to convince others that I said anything remotely resembling that. The truth is that the markets are not as efficient as you believe they are.

      If you didn’t use such extreme language, we could have a discussion. On my part ‘myth’ was an over-statement. It’s a myth in my opinion. But I do not stand alone. The majority still believe in the theory. But that alone does not make it true.

      I am not afraid to invest in the stock market. But some people are terrified, yet do invest because they are told they must own stocks or lose value due to inflation. It’s the Prudent Man Rule being rammed down the throats of reluctant investors. That set of rules requires some updating – just as it has been updated in the past.

      This guest post is an introduction to the topic. It is not a call to action. It’s making the suggestion that passive investors consider adopting risk-reducing option strategies as part of their overall strategy.

      It’s also not a detail-filled description containing tid-bits of information that can make the process somewhat more efficient – for those who have the time and inclination.

      In your example you chose an inefficient collar. Studies have shown that owning a longer-term put is more efficient than the short-term put. That alone could increase returns. But those details are not important. First comes the decision: Do I bother to learn more about options?

      One recent study reports that collars earned profits over a 10-year profits when the buy and hold portfolio declined by more than 3% per year. Because I find some results to be too pro-collar and anti-buy and hold, I’ve discounted the value of that study – but it’s still pretty impressive.

      Collared portfolios earn more than the risk-free rate when the markets are rising. You can choose your own strike prices to modify the collar. How can you decide the profit potential is the risk free rate?

      An investor does NOT have to pay the spread. Markets are negotiable.

      Nor are commissions a factor, unless you prefer to use a costly broker.

      Your mind is made up. You don’t see benefits because you don’t want to see them.

      Anyone who is basically optimistic, unafraid of the future, sure the markets will recover and soar over time does not need the insurance that more conservative, or more pessimistic investors need.

      If you have steadily rising markets, then absolutely – collars are going to under-perform. So, as I said, if that’s your outlook, or that is the chance you want to take – then take it. I’m not going to say it’s a terrible idea – at least not for you.

      For those who fear a bear market, or are convinced that the future of the country has been altered by this economic crisis, or who have already accumulated all they need for a lifetime – then taking out a guarantee is a good idea. But, it’s not for everyone.

      You seem to believe that collars are not good for anyone. I know you are behind the times.

      • Juan says:

        Hi Mark,

        I was reluctant to nod my head at your post as well as responses until I read this last response you wrote. Your insurance stategy is effective during periods of uncertainty and large downsite potential like the one we all experienced in the last 12 months. Why would we want to limit our potential in times of “green chutes”? Wouldn’t a protective call or put strategy make more sense. I think the best strategy is buy and hold but dont go away. If you see high periods of uncertainty then options provide a nice income off the premiums. What is scary and makes options definetely not for everyone is the fact that the options market has to to net out. There must be a loser and winner.

        • Hi Juan,

          Protective puts sound good, but the cost of puts is so high that you would have to make a lot (probably over 20% per year just to overcome the cost of the puts). That’s why I use collars. The call sale pays for the puts.

          Your suggestion makes perfect sense. The difficulty is knowing just when is the appropriate time to get defensive. I never know in which direction the market is going to move, so for me the recommendation is to cover x% of your portfolio with collars. That can be 0% when you want to take a bullish stance, 50% all the time; or 100% whenever you deem it appropriate.

          It’s a very flexible method. If you have market timing skills use them. But statistics tell us that the vast majority of investors lack that specific skill. That’s why I suggest owning protection for a portion of the portfolio at all times.

  6. Dave says:

    LOL you guys are a tough crowd. It’s a little sad, really, because Mark is quite an amazing teacher, nothing remotely like the typical “option expert”.

    And, from an oldster, here’s how it really works: To grow your capital significantly over the “long run” you need to focus on NOT losing– don’t worry so much about how big you (hope) the gains might be.

  7. Dylan says:

    Mark,

    I think you may be catching some flak because of the way you open your post and those questions you ask followed by the statement, “today’s investors can do better.”

    It’s not really until your subsequent comments that you acknowledge that it’s a strategy for “more pessimistic investors,” “those who fear a bear market,” and those who “are convinced that the future of the country has been altered by this economic crisis.”

    It’s quite apparent that you are passionate about options, but people (even those that understand options and markets) are not all going to agree with you. That shouldn’t be taken to mean they’re open to the idea, they just don’t agree. Disagreement is what keeps the options market alive.

    Some of the other commenters could just as easily argue: Your mind is made up. You see benefits because you want to see them. Or, you don’t see all the costs because you don’t want to see them.

    On EMH, you respond to Chuck that “the truth is that the markets are not as efficient as you believe they are.” I don’t know about anyone else, but couldn’t tell from Chuck’s comment how efficient he thinks they are. But, even if you could, you could only make that claim if you knew how efficient they are or are not, in truth. But then you say, “it’s a myth in my opinion.”

    The truth is that EMH is not a fact or a myth. It’s a hypothesis, an attempt at an explanation based on observations. It is not until a hypothesis has been conclusively proved or disproved can its status as a fact be argued. For many passive, buy and hold investors, EMH provides an explanation, but it not the reason for passive investing. Finite math provides the reason. The finite math shows us that beating markets is a zero-sum-game before considering costs. This is true in both efficient and inefficient markets.

    Another error people tend to make is concluding that “efficiency” in EMH equates to being rational or correct. Most will acknowledge that the market can be highly irrational and often incorrect. The efficiency has to with how easy of difficult it is to exploit and profit from irrational and often incorrect. The real question traders need to ask is not whether or not markets are efficient; it’s whether they are efficient enough that the trader cannot identify and exploit mispriceing on a regular and ongoing basis.

    I’m not anti-options or anti-collaring, I just don’t see a constant need for insurance if you are not planning to raise cash from you investments anytime soon. I liken it to buying trip insurance for a trip you’re not even going to book.

    • Dylan says:

      Oops, I meant to say: That shouldn’t be taken to mean they’re *not* open to the idea.

      • Thanks for the response Dylan.

        Disagreement is fine.

        All I’m trying to do is alert passive investors to the idea that collars offer guaranteed protection to those who are willing to accept the costs. The big cost is a limited upside.

        Not trying to tell anyone this is anything other than a viable alternative worth considering.

        BTW, it’s not only for pessimists. It’s for anyone who just cannot afford to lose a chunk of his/her portfolio.

        I see the costs. That’s why I always say it’s a trade-off. I also suggest the idea of using collars on a portion of a portfolio. This specific rap – that I don’t see the costs – is particularly unfair.

        I have a quibble: Everyone has already booked this specific vacation. They have an investment portfolio and must decide what to do with it.

        My beef is that the professional planners etc cannot see outside the box in which they are locked. And that means fewer choices for their customers. That is not a good thing.

        Regards,

        • Chuck says:

          Yes, well I’ve given my professional planner the heave ho… :)

        • Dylan says:

          Mark, you are again reading things that are not there. I didn’t claim that you don’t see the costs. I said others could just as easily make that agreement. This was in response to the “specific rap” you made that another commenter doesn’t see the benefits (I used your exact same words, just substituting “costs” for “benefits”) – is that not particularly unfair also?

          I don’t think it’s fair to conclude that professional planners “cannot see outside the box in which they are locked.” I’m not saying you are locked in a box, but how would my making that claim be any more or less justified than your claim?

          You say that you’re, “not trying to tell anyone this is anything other than a viable alternative worth considering.” But if we consider it and don’t think it applies in the same way, you seem to criticize us. Are you asking people to consider it or to embrace it?

          I think you missed the point of the travel insurance analogy. If an investor has no immediate plans to sell investments, even if their investments experience a huge price drop, then they don’t need to pay the cost of insuring it right now. On the other hand, if an investor has plans to raise cash by selling investments (the trip) and couldn’t afford to wait for a price recovery, then insurance might be useful.

          On several occasions, you acknowledge that collars are not for everyone, but you also seem also argue with the idea that they’re not for everyone as in your quibble with my analogy that “everyone has already booked this specific vacation.” Either it’s for everyone or it’s not for everyone? I’m not sure at this point what your position is?

          • I’m disappointed that I have only heard of one financial planner who has used options. Granted I don’t know many, but there are bloggers who are pros and the Prudent Man rule seems to be the status quo.

            Here’s why I believe planners refuse to learn about options: a) they have heard options are risky tools from people who don’t know how they are used to reduce risk and especially, b) If they use options and the client loses money, they know the client will sue based on those same stories that ‘options are dangerous.’ It’s prudent for the planner to avoid taking that risk for his own protection. Prudent – but unfair to the client.

            Options are not dangerous. What is dangerous is options in the hands of gamblers.

            To reply: Sure, I’d like to see people embrace it, but it’s not for everyone. I may be reading too much into the responses, but it seems to me that the replies are saying: options – forget them.

            My position is that anyone who has stock market investments ought to be aware that collars exist. And for those who would love to have a guarantee of very limited losses – the price to be paid is either accepting similarly limited gains, or pay more cash for the portfolio protection and give yourself the chance for better – but still limited gains.

            Regarding the need for insurance when you have no plans to sell: We have had this discussion before (I’m almost certain it was with you). When the portfolio value has declined, you have a loss. It may be unrealized, but it is a loss. To pretend otherwise ‘just because I’m not selling’ is not living in the real world.

            I believe it’s MUCH better not to suffer those losses – even when I don’t have to sell soon – and to accomplish that, portfolio insurance must be in place. I choose collars. Others choose allocation. No one is ‘wrong.’

          • Dylan says:

            Well then, Mark, I guess I’m not living in the real world, but at least no one is wrong.

          • Andrew says:

            Mark, please explain _in detail_ why you care about unrealized losses. Thank you!

          • Dave says:

            Forgive me for stating the obvious; the ugly math on “unrealized” losses:

            Stock drops 50%… Stock now needs a 100% gain to get you back to even:

            Now, because you were so worried about limiting your upside… because you couldn’t accept the possibility of just above average gains… preferring instead to HOPE for a homerun… You sit HOPING for a double to BREAK EVEN—back to where you started!

            I guess I should be glad some people still feel that way (I’m not). Because my job is to hunt folks that think that way down, and to reduce the size of your account. Nothing personal, it’s just what I do.

  8. Chuck says:

    When things get tough (like “the worst economy of the millennium” we’re supposedly in), it’s inevitable that people tend to leave behind the old reliable and try to take on the modern, hip thing that all the cool kids are doing. Those that do are wise to take some advice from Warren Buffet in a piece now titled “How to Minimize Investment Returns:”

    http://www.marketriders.com/pub/1/Warren%20Buffett%20On%20Fees.pdf

    Look, I have nothing against options. I use LEAPS instead of shares for some of my riskier holdings, to protect from loss and to gain leverage. But I know exactly what I am paying for that privilege, and I won’t pay the premiums for the long term, because the compounding cost will eat my lunch.

    When you buy and hold, you are investing. When you trade, you are speculating. That is, trying to trick other investors into giving you their investment gains. That can only work for so long. When your opponents in the market figure out what you’re doing, the margins will become razor thin until only the market makers can profit, or you’ll get front-runned into losses. But you’ll think you’re doing great until you get burned.

    This was an interesting debate, and I hope readers can look at both sides and come to a rational conclusion for their own circumstances. People are scared and looking for answers, and this is not an investing forum, so I don’t want anyone misled into thinking you can get stock returns without risk.

    BTW “life savings in jeopardy” was your own quote, dude! It was your characterization of buy and hold investing. A careless hyperbole (or “extreme language?”) that I’m amused that you actually chastised me for! It certainly turned me off from reading the rest of your reply. :)

  9. Chuck says:

    Another BTW: Mark, if you were more confident in your ideas, you wouldn’t have to be so abusive to your critics. Your ideas should stand on their own merits. You’re supposed to be the author slash professional options trader here. Act like a professional and I would respect you more.

    • I don’t believe I’ve acted unprofessionally. If I have, I offer sincere apologies.

      I believed the criticism was harsh and I tried to make an appropriate response.

      I began my efforts to suggest collars before last year’s market decline. But, obviously, the idea would be more appealing to people who incurred large losses, and I started talking about collars more frequently. We all know how healthy youngsters shun health insurance. It’s the same idea. Few considered the idea of owning some portfolio insurance. Maybe it’s an idea to consider now. Especially after the recent run-up. [No, I am not preaching market timing.]

      I honestly didn’t recall using that line: in jeopardy. I apologize for attributing it to you. In fact I find it difficult to believe I used that phrase.

      Bottom line: Collars do the job they were designed to do. The question is whether an investor wants to depend on methods that are considered to be ‘tried and true’ or whether an alternative is just as good or better. It’s an individual decision, based on one’s comfort zone.

  10. Andrew says:

    If you are concerned about protecting the value of your investments, put them in the mattress or in an FDIC-insured bank account. The entire point of equity investing is that you risk losing the principal, while the upside is that you can make a lot more than a bank account over the long term. To limit your losses while also limiting your gains sounds foolish to me. To do so while adding a layer of complexity sounds mega-foolish. Of course, that’s just my opinion as a 44-year-old buy-and-hold investor.

    • If B&H is for you, then congratulations on finding an investment strategy that works for you.

      One thing to consider: We have had a stupendous bull market – with interruptions – since WWII. You are wagering that the general trend will continue over the next 20 years.

      I am afraid to make that wager.

      Most people insure their houses, knowing the chance of a fire, or other disaster, is small. That insurance is costly.

      I like the idea that portfolio insurance is available. No one has to buy it.

      • Andrew says:

        My homeowner’s insurance is about $1,600/year. The replacement value of my house, not counting clearing away the debris of the old house, would be at least $500K. That doesn’t seem expensive to me. And all I have to do to maintain this coverage is write a check once a year. Your plan requires a lot of work, and frankly, I can’t even understand it, and I’m smarter than 98% of the population in terms of raw IQ (though perhaps not in terms of knowledge of financial markets). Besides, if what you’re doing is so lucrative, why are you willing to share it?

        • Andrew,

          1) I never said it was lucrative.

          2) In fact I stated that during rising markets the strategy under-performs. It compensates nicely during bear markets.

          3) It’s not a secret. Anyone who is familiar with options already knows about collars.

          4) I’m sharing it – and this is a very appropriate forum – with many investors who have probably never considered using options.

          5) This is a widely read blog and there are lots of investors here. Many passive investors are buying index funds and are happy doing that. They get the fact that trying to out-perform the averages is a losing effort for most.

          Most understand the idea that diversification helps reduce risk.

          Many get the concept of asset allocation, but not everyone take the time to do it.

          But very few know that collars are available to cut the risk of loss. Why should anyone deny them the right to make this discovery. I’m here to introduce the concept of options. After that, it’s no longer my decision.

          I am ‘sharing’ because I believe that a high percentage of average investors – both active and passive – can benefit from knowing that there will never again be a devastating portfolio loss. Or even a large loss. Or even a medium-sized loss.

          For those who treasure that insurance – for those willing to accept a limited upside – for those who know bull markets do not last forever – for those investors who cannot afford (or are unwilling) to take losses – for them, the collar is a good deal.

          For you it is not a good deal.

          One reason it’s such a ‘secret’ is that the professional stockbrokers, financial journalists, financial planners and advisors are either unaware of collars, or more likely, are unwilling to recommend them to clients.

          If you consider your homeowner’s insurance as ‘cheap,’ why can’t I consider collars to be worth every penny of the potential cost? I say ‘potential’ because there is no cost if the markets do not rise significantly.

          I think collars are cheap. despite the ‘work’ – which decreases rapidly as you gain experience.

          You say you cannot understand the strategy. Then how can you pass judgment? I’m sure a smart guy like you doesn’t make a habit of doing that. What is there about my post that disturbs you so much?

    • Excuse me??? The whole point of investing is to risk losing the principal?

      If you believe that, then I understand why taking out insurance that limits gains seems foolish to you.

      The whole idea of investing is to minimize risk while seeking gains that compensate you for taking that risk.

      If you are looking for huge returns, then you may indeed be forced to risk it all. But to seek above average stock market returns – which is impossible for the majority of investors – is no reason to risk losing it all.

      I believe you will discover that most investors prefer some type of risk management.

  11. eric says:

    Hey Mark,

    Thanks for the intro on options collars. I definitely can’t say I understand them but I appreciate the perspective.

    I think I will stick with B&H but this idea leaves something to munch on.

  12. Andrew,

    1) I do not care about ‘unrealized losses.’

    2) I mentioned it here because it was in response to Dylan. In a previous discussion elsewhere, I believe it was Dylan who said that it you don’t have to sell (i.e., if you don’t have to realize the loss) then there is no loss.

    3) I raised the point here because Dylan said “If an investor has no immediate plans to sell investments, even if their investments experience a huge price drop, then they don’t need to pay the cost of insuring it right now.”

    I disagree. All investments should be protected in some fashion. regardless of when the investor plans to sell.

    That’s all the ‘detail’ I have.

  13. zoltan says:

    you did a GREAT job on the issue of collars. I wish I had known about this in 2007, 2008, early 2009. Unfortunately I did not.
    I now understand it, and will hopefully be able to use it.
    Please proceed to issue other articles as I found the collar excellent.
    Question…would it be more economical to sell calls monthly rather than matching the put strike month?
    What would be your thought and perhaps experience with how the call could be used best to offset the put cost?
    Best regards
    Zoltan

  14. Kidar says:

    For those who does not consider collars, I would suggest to calculate Return on RISK (ROR) on collar and return on RISK for STOCK holding. In both cases the strategy is Buy and Hold. But when you are 60 you may not have all decade to wait for stock (or market) to recover. COLLAR is unbeatable for ROR. One more thing is that market goes down faster then up, which bring additional benefit for COLLAR strategy, compare to bare stock holding.

    Safe investing
    Kidar


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