Investing in listed stock options is often considered speculative, but options can also be a valuable tool to help reduce overall portfolio volatility and generate additional income for your equity portfolio. Option strategies may also be used in some cases as an equity substitute, providing you with similar return potential, but with significantly less total capital invested. Not every option strategy is appropriate for every portfolio or every client. That’s why, as with your equity portfolio, we customize our option overlay to meet your goals and risk tolerance.
Depending on your tolerance for risk and opportunities available
in the market, we utilize four types of option strategies.
Defensive
We may write defensive covered calls on particular stocks in your portfolio when we believe there could be a near-term correction in the underlying shares, the company’s sector, or the overall market to help reduce the volatility of total returns. We may also write calls when a stock position is within 10 percent of our target price with the intention of being called away at a higher price. These calls are usually written “at” or “in the money” where premiums are the highest and most often written in the current month.
Strategic
We may choose to write strategic covered calls to bring additional income into your portfolio in addition to any dividend from the stock. We typically use this strategy by writing 3-month calls on a regular rotational basis. At times, we may close the option position early and roll out the covered call to a higher strike price if we decide not to be “called away” on the underlying stock. This strategy usually involves selling “out of the money” calls and receiving small but regular premium income.
Tactical
We may decide to tactically sell puts to bring additional income into the portfolio. This strategy may be used to establish an entry price for a stock we wish to buy at a lower price. Rather than acquire the stock at its current price, we sell a put, usually “in the money”, thereby receiving premium income for agreeing to buy the stock at a certain price. If the put is not exercised, the premium becomes 100% profit. And if the stock is “put” to us, we’re comfortable owning the shares at the strike price less the premium we received for selling the put.
Opportunistic
At times we opportunistically use option combinations that include both puts and calls as a synthetic stock replacement strategy. A typical bullish combination might involve selling a put option and using the premium income to offset the cost of buying a call option on the same security. The net result is about the same as owning the underlying security; you have similar upside appreciation potential, but with the added benefit of committing little or no capital.