Diversifying Income Sources with Option Overlay Strategies

Advice to the Advisors

Sheaff Brock Institutional Group | Option Overlays may be Misunderstood

Diversifying Income Sources with Option Overlay Strategies

In a 2010 Songfacts interview, rock songwriter Eric Burdon complained that he’d really been misunderstood: “by my mom, my dad, school teachers, a couple of the women that I married. I’ve been misunderstood all of my life.”In a 2010 Songfacts interview rock songwriter Eric Burdon complained that he’d really been misunderstood: “by my mom, my dad, school teachers, a couple of the women that I married. I’ve been misunderstood all of my life.”

Options, Sheaff Brock Managing Director Dave Gilreath laments, have been misunderstood as well. Options are generally thought to be risky, he acknowledges, yet selling covered calls can be a way to reduce risk. And despite the fact that the selling of option premiums has been around for decades, he laments, options too often get a “bad rap.”

But, for those financial advisors who accept the challenge of explaining put option strategy, the opportunity exists to open a door for their clients to use exchange-traded put index options to achieve potential additional income, albeit with some additional risk. 

After first ensuring that a client is suitable for an option strategy and understands all of the investment risks, Gilreath lists his preferred client profile for taking advantage of a Sheaff Brock overlay strategy:

  • long term mindset
  • large position in a single equity security or in a portfolio of individual bonds
  • upward bias—belief that the market will grow, or at least maintain, its overall worth in the future

The Sheaff Brock Option Overlay strategy:

Index Income Overlay—An overlay strategy on the sale of a put option credit spread on an S&P 500 ETF to generate additional income. A short put is sold, usually 3% out-of-the-money, and that option is paired with a long ‘insurance’ put, usually with a strike price 15% lower.

What an option overlay strategy IS—a long-term, time-premium capture strategy

What an option overlay strategy IS NOT—a trading strategy

While options may have been misunderstood by the masses, Sheaff Brock believes that selling put options—for investors who can add some additional risk and maintain both general market optimism and healthy doses of patience—may be an effective way to achieve cash flow (and eventual capital gains). 

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