Equities

Risk and Return of Equity Index Collar Strategies

Topics - Equities Trading

${ numberSection } ${ text }
Risk and Return of Equity Index Collar Strategies

Equity index collar strategies are often perceived as a way for investors, at little to no cost, to exchange some upside exposure for reduced losses on the downside. That perception may be accurate if one considers only the net dollar cost of the strategy’s initial option trades, but the authors of this paper contend that it fails to account for the significant drag the collar may impose on returns.

To make their case, the authors decompose the equity index collar’s returns, seeking to show that it is expected to have lower returns than its underlying index, primarily because it earns less equity-risk premium. Additionally, they write, collars that are net long volatility exposure may further reduce expected returns because they pay out volatility risk premium.

The authors then compare the collar to other ways of obtaining equity exposure with reduced downside risk. Their analysis attempts to show that not only has the collar strategy historically performed poorly relative to these alternatives, but investors should expect it to continue to potentially underperform in the future.

 

 

Published in

The Journal of Alternative  Investments

AQR Capital Management, LLC, (“AQR”) provide links to third-party websites only as a convenience, and the inclusion of such links does not imply any endorsement, approval, investigation, verification or monitoring by us of any content or information contained within or accessible from the linked sites. If you choose to visit the linked sites, you do so at your own risk, and you will be subject to such sites' terms of use and privacy policies, over which AQR.com has no control. In no event will AQR be responsible for any information or content within the linked sites or your use of the linked sites.

 

The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of AQR Capital Management, LLC, its affiliates or its employees. This information is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein. Past performance is not a guarantee of future results.

 

Hypothetical performance results have many inherent limitations, some of which, but not all, are described herein. Hypothetical performance results are presented for illustrative purposes only.

 

Diversification does not eliminate the risk of experiencing investment loss.

 

Certain publications may have been written prior to the author being an employee of AQR.

This material is intended for informational purposes only and should not be construed as legal or tax advice, nor is it intended to replace the advice of a qualified attorney or tax advisor.