Rohan Reddy“The idea that a bell rings to signal when investors should get into or out of the market is simply not credible. After nearly 50 years in this business, I do not know of anybody who has done it successfully and consistently.”
The memorable adage from John C. “Jack” Bogle, founder of Vanguard, is more relevant than ever after a volatile 2018. Over the course of the year, particularly during the turmoil in Q1 and Q4, many investors found themselves re-examining their investment strategies and succumbing to portfolio decisions driven by emotional distress brought on by substantial fluctuations in the market.
Often during periods of heightened volatility, staying the course and sticking with a strategy can be preferable to overreacting to recent information. Just because the market starts to dip doesn’t mean that one should rid themselves of standing allocations. As a market participant it is pivotal to ask the question, “has anything fundamentally changed with the analysis justifying that security or allocation?” If not, selling just because the market is going through a volatile period can introduce new risks to a portfolio.
Should an investor determine that taking action is necessary, there are a number of tools that can potentially help generate a measure of downside protection for a portfolio, without taking a more dramatic step of simply selling assets to hold cash. One such tool includes exchange traded funds that use options strategies, like writing covered calls.
Global X offers two covered call strategies, the Global X Nasdaq 100 Covered Call ETF (QYLD) and the Global X S&P 500 Covered Call ETF (HSPX), which both pursue strategies that offer investors potential monthly income with lower volatility than the funds’ broad market indexes. These funds aim to complement an investor’s current equity and income investments.
The following three tips on call options and ETFs that use options can be considered by investors and advisors looking to navigate volatile markets.
1. Options Strategies can help in volatile environments
When volatility rises, an investor can potentially benefit by utilizing option strategies in their portfolio. Although more complex than traditional investing, options strategies can help provide a measure of protection to their current holdings. One such strategy is to sell covered call options. If the fundamental view of a company hasn’t changed, but the current market environment shows signs of volatility, an investor could potentially gain a measure of downside protection as well as help generate income through selling a call option on a current stock holding. Writing covered calls, however, limits the upside potential of the underlying security.
2. Writing calls can benefit from higher volatility
Say an investor owns 100 shares of company “ABCD” and sells one call option on the 100 shares they own. In return for selling a call option on company ABCD, which gives the investor the right but not the obligation to buy 100 shares of ABCD at a predetermined price (strike price) in the future, the investor receives a premium, yet forgoes the upside on stock ABCD if it appreciates above the option’s strike price.
Writing a call option can provide a level of downside protection because historically as volatility increases, the amount of the premium received when writing a call option generally increases as well, potentially offsetting losses the stock incurred during the volatile environment.
Exchange traded funds (ETFs) that utilize options strategies can eliminate the call writing work for the individual investor. Many of these ETFs take a broad-based index approach where they own the stocks in a U.S. equity benchmark, such as the S&P 500 or the Nasdaq 100, and sell call options on the index.
3. Keep Long Term Goals in Mind
As an investor, it’s important to take long-term goals into consideration before making any sudden changes in one’s portfolio construction. It’s understandable that many investors may still have scars from the tech bubble in the early 2000s and the global financial crisis in 2008. At times when volatility rises and markets are moving hundreds of points a day, it can be a challenge for investors to remain calm and maintain focus on their long-term investment objectives.
In light of 2018’s bouts of increased market volatility and growing geopolitical instability, investors face new and uncertain market dynamics. Investors can find new ways to navigate markets by looking beyond the traditional tool box as they strive to achieve their specific investment needs. ETFs that employ options strategies can potentially benefit a portfolio in a multitude of ways during such challenging environments by potentially generating income and potentially providing a level of downside protection that historically has increased with greater volatility.1