QQQQ With Collars – Returns

Friday we discussed passive and active collars for the Nasdaq 100 ETF, QQQQ from a paper by Szado and Schneeweiss, which you can download from the bottom of that post. Here, we will look at the returns of the different strategies, and compare that to owning the index itself.

Owning $100 of the Nasdaq 100 ETF from April 1999 to May 2009 would result in this roller coaster ride (Click on the image to enlarge):

Passive Collar

We want to compare this to the collar strategy in each of the sub-periods outlined in the graph. The title on this graph in incorrect, we are comparing one month, three month, and six month puts. (Click on the graph to enlarge.)

Here is how the passive collar strategy does:

• The dark green line is the return for the strategy of owning QQQQ and selling at the money one month calls and buying at the money one month puts. It has a steady bond-like return where $100 grows to about $140 in ten years. That is a 3.4% compounded return.
• The purple line is the return for the strategy of owning QQQQ and selling at the money one month calls and buying at the money three month puts. Here, most of the increase is in the early period, from March 1999 to March 2003. Starting with $100, it grows to about $180 in this period and then in the next six years, increases to about $190. This is a 6.6% compounded return over the ten years.
• Similarly, the turquoise line, which is the return for the strategy of owning QQQQ and selling at the money one month calls and buying at the money six month puts, rises to $275 by September 2003 and then treads water until March 2009. This is a very respectable 10.6% compounded return over the ten years.

The passive strategy is most sensitive to the put expiration. So we look at 2% out of the money puts written six months out and see how the return varies with how far out of the money the one month calls are written.

This is for the whole ten year period:

• The passive collar strategy cut the standard deviation of return by two thirds from 30% to 10%. This is a very substantial improvement.
• Of course, it also turned a losing strategy, owning the Nasdaq, to a nine to ten percent per year winner.
• The maximum drawdown for owning the QQQ was 80%, nearly impossible to recover from. The collar had a maximum drawdown of 21% for the loosest collar.
• The correlation with the underlying increases as we loosen the collar by increasing the amount that the call is out of the money.

Active Collar

(Click on the graph to enlarge.)

The upper turquoise line is the short term active strategy. It turns $100 into $300 in ten years, which is an 11.6% compounded return. All the return was made by September 2003, the strategy treads water after that.

Tomorrow, we’ll look at what it all means.