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Mutual Fund 'Collars' Losses, Limits Gains

Stocks in this article: COLLX POT RIMM

NEW YORK ( TheStreet) -- The curiously named Collar Fund (COLLX), which was started last June, follows a unique strategy among stock mutual funds. And its volatility resembles that of a bond exchange traded fund.

"Collar" may ring a bell, as it's named for an options strategy. A collar consists of buying a stock, selling a call option and using the proceeds from the call sale to buy a put option. The Collar Fund targets call options at about 10% out of the money and put options at about 10% out of the money, dramatically reducing volatility. The fund is managed by Summit Portfolio Advisors, a firm that has followed such a strategy for separate accounts for several years. The fund ought to have a high correlation to the stock market but with a fraction of the volatility.

I had a chance to talk with lead manager Tom Schwab. He gave the following example to illustrate what the company does. It owns proprietary software that screens for attractive options pricing among mostly large-cap stocks. If the screen finds a stock trading for $100 a share, managers will look at the options pricing. They would be inclined to sell a call option struck at $110 and buy a put option struck at $90.

A call option priced higher than the put option would be attractive. There are two reasons for this. If managers can sell a call for $8, to use Schwab's example, and buy the put for $6, the fund pockets the $2 difference. In addition, such a move would be viewed as a positive-sentiment indicator because the market would be willing to pay more for an upside move than downside protection.

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