What is Collar Investing? • Collar investing is the simultaneous purchase of a stock and a put option, along with the sale of a covered call option; the put contract protects the new stock while the covered call limits the stock’s upside, but also finances the put premium. • The art of Collar Investing is to find those combinations offering the greatest reward with the least risk. • With Collar Investing, the focus shifts from stock selection to collar selection.
Financial Planning with Greater Certainty • Eighty year S&P Average 12.3% • Standard Deviation 20.2% • Actual Return Between 11 - 13% 4 Years • Range -43.35 to + 53.93%
Absolute Risk - How to Cope • Types of Risk • Specific Security Risk • Diversify with low correlation stocks • Industry Risk • Diversify with non-cyclical stocks • Style Risk • Diversify with emphasis on Lg Cap Value-Higher Div • Market or Systematic Risk • Un-diversifiable-normally requires asset allocation to non-equity sectors. • Consider Collar Investing
Equity Collar Backtest • Observations : • +20%/-10% collar returns = 52%/48% stock/bond mix. • Best 52/48 yr = 28.9% vs. 20% for collar. • Worst 52/48 yr = -23.7% vs. -10 for collar. • Setting asset allocation max loss to -10% needs 19%/81% S/B mix. • +20%/-10% collars 27% less than S&P with std. dev. 41% less.
Collars Vs. Asset Allocation for managing equity risk. • Collars limit systematic risk, allowing higher stock mix. • Collars precisely define risk and reward. • Provide more certainty than asset allocation. • Enable clearer communication with client.
Risk vs. Regret • Investor2 • 100% Equity • Switch to 48% Debt 52% Equity Investor1 • 100% Debt • Switch to 48% Debt 52% Equity Both have same risk/return tradeoff Now Stocks rise by 20% Bonds rise by 5% • Pleased at return • Has some regret No regret for collar investor if satisfied with pre-determined range of returns
Final Comments • The equity collar is bounded by its predetermined limits and not the assumption that the historic pattern of returns will present itself in the future. • It reduces the potential regret that an investor may experience from receiving an unforeseen decline in asset values. • The collar is beneficial in reducing uncertainty and helpful in managing systematic risk.