For the Right Clients, Option Premiums Can Offer Additive Returns

Advice to the Advisors

Elevator panel controls | Sheaff Brock | Option Overlay for Additive Returns

For the Right Clients, Option Premiums Can Offer Additive Returns

“Most economic indicators are benign,” James B. Stewart commented in a New York Times article towards the start of 2019, noting the exceptionally low unemployment rate and low inflation. In an earlier First Trust Monday Morning Outlook report, Chief Economist Brian S. Wesbury made some positive observations of his own that may still be relevant: “As the summer goes on, we expect evidence will continue to show that the economy isn’t slipping into recession.” Wesbury makes note of several positive factors presently in play:

  • home building has room for further growth
  • household debt relative to assets is low
  • banks are in strong financial shape
  • corporate debt are below normal relative to assets

Reflecting on the “rough month” investors experienced in May, Sheaff Brock Managing Director Dave Gilreath comments that “stocks often take the elevator down and the stairs up,” with the market taking a breather before rallying up to a higher plateau. Gilreath points specifically to the strong rallies following the stagnant markets in 2004–2005, 2011–2012, and 2015–2016.

Dow Jones Industrial Average 2004-2005

Dow Jones Industrial Average 2011-2012

Dow Jones Industrial Average 2015-16

With the Dow Jones “stuck” for the past year-and-a-half, Gilreath observes, it’s not unreasonable to anticipate a new “stair-climbing” period. In fact, he adds, those three rallies represented respective gains of 25%, 35%, and 45%, In contrast, our DJIA “stair climb” would need to rise only 15% to hit the 30,000 level. Needless to say, he cautions, “nobody has the slightest idea what the market will do.”

Meanwhile, he notes that spikes in volatility such as the one in May can serve as a cash-flow benefit in overlay strategies. Sheaff Brock offers two option overlay strategies, Index Income and Put Income.

The Index Income Overlay seeks to generate additional income through the sale of put options on an S&P 500 ETF. In the Put Income Overlay, puts are sold on high-quality equities to generate additional income, using a concentrated equity position, bond portfolio, or other equity portfolio as collateral.

Advisors might consider these two option overlay strategies for investors who are comfortable with taking additional stock market risk with an opportunity for added cash flow. Option overlay strategies outsourced to Sheaff Brock use the client account as collateral but can allow the account to remain intact.

Option premiums from an overlay strategy can provide additive returns to help cushion “elevator rides.”

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