Option Overlay Strategies—Timely, Yet Timeless

Advice to the Advisors

Option Overlays Timely and Timeless | Sheaff Brock Institutional Group

Option Overlay Strategies—Timely, Yet Timeless

One over-arching theme in any financial-advisor-to-client messaging is the power of time, with the goal being to select investment tactics which are timely, yet which belong in portfolios based on timeless wisdom. In that context, option overlay strategies, Sheaff Brock posits, become a particularly relevant topic.

There’s nothing new about option overlays. In fact, as Institutional Investor explains, the majority of U.S. pension plans have adopted overlay techniques as part of their investment tactics. And, while in investment vocabulary, the term “overlay” can have different meanings. Sheaff Brock Managing Director Dave Gilreath offers a straightforward definition: the use of derivative investments with an underlying securities portfolio serving as collateral.

“Asset allocation is like a car with four-wheel drive,” an article in the Orange County Fire Authority Deferred Compensation Plan newsletter explains. While four-wheel drive is not guaranteed to prevent your car from slipping, having it could be a protective tactic—you have a better chance to gain traction. As investors sense the advent of a period of higher market volatility, it may be timely to incorporate portfolio tactics such as overlays.

The “four-wheel drive” aspect of option overlay strategies comes in the form of income. The intent is, by being a seller (writer) of options, rather than a buyer, an investor may be able to generate repeatable, incremental monthly yield from assets that would otherwise have little or no cash flow.

You might find the Option Overlay conversation most relevant for those of your clients with:

  • a long-term mindset
  • a large, monochromatic position in a single security or in muni bonds
  • an upward bias—belief that the market will grow, or at least maintain, its overall worth in the future
  • a desire to potentially increase income in exchange for higher exposure to volatility

Sheaff Brock’s primary Option Overlay strategy is:

Index Income Overlay—A put option credit spread is created 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.

Option overlay strategies are very timely, Sheaff Brock’s Gilreath notes, given the recent increases in market volatility.

In another sense, option overlay strategies are also timeless. For many decades, they have been employed by those with general market optimism and healthy doses of patience

Why? The potential for long-term improvement of risk-adjusted returns.

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