For anybody in the financial markets, 2018 won't be forgotten anytime soon. We had record highs for stocks, followed by big, bearish moves downward. We had spikes in volatility, and we had the ongoing debate about what's next for the U.S. and world economy. Add in Brexit, questions on America's trade deals, Fed rate hikes, and the back-and-forth in Washington, D.C., and it's no wonder we're seeing an increase in angst.
Have you been hearing more from your clients who are concerned about volatility? It certainly wouldn't be a surprise if you are.
In my prior life as a producing manager at a large wire house firm, I was on the same side of the desk you're on now, so I know it's rarely easy. I commend you for the field you've chosen and for wanting to be successful for your clients, but we're all aware that challenges are ever-present between clients and advisors. To keep these relationships on the right track, one of the keys for advisors is to differentiate themselves from their competition, especially when investment uncertainty seems to be growing.
How can you do that, though? Based on quantitative research commissioned by the OIC and conducted by Cerulli Associates, advisors may want to consider adding option overlays to clients portfolios.
To address the elephant in the room that is volatility and the ways to manage it tactically in 2019, it is important to recognize that stocks don't only go up. Sure, it's been an unprecedented run since early 2009, but there have also been a few pullbacks along the way. With that in mind, advisors may want to consider brewing up a portfolio that has the potential to ride out the rockiness with protection and possibly an income stream.
There is no right strategy for every situation or every moment in time. However, with some research and planning, you can determine the best approach for each client. Here are a few interesting and timely option strategies for you to consider amid the current volatility:
- One common protective move investors have used for years is buying puts on an existing holding. Yes, this will cost money to initiate, but if the client's underlying stock or ETF drops, the value of that put would be expected to increase. If it does, the put could mitigate the loss on the underlying.
- Another possibility is to sell calls on an underlying and collect income upfront, lessening the pain during a decline. Covered call writing programs can generate income especially in the current low interest rate environment.
- Yet another possibility to consider is buying a protective put and selling a covered call at the same time. That's called a collar, and it's another widely used strategy. A collar brings in immediate income that offsets some of the price paid for the put, and it combines downside protection with a defined exit point on the upside.
Now, you may be asking the question: Don't options just mean more risk? Certain option strategies can have risk, but they don't have to be high risk, and they don't have to be overly complicated. If you believe options are only for the biggest portfolios or for clients who want to take on outsized risk, I can tell you there's a lot more to it than that. Options can be for small and medium-sized accounts, and some strategies can even help reduce risk, not add to it.
That's because with options, there are numerous types of strategies, including several for hedging and others for dealing with higher volatility. Just as there are a lot of ways to take your coffee in the morning, there are many varieties of options - you can pick and choose any flavor you and your clients want for their portfolios.
I know it can be difficult to have a productive, action-oriented conversation when the markets are slumping, soaring and then slumping all over again. Through Coffee With Cott, I want to provide valuable educational tools that can be used to energize conversations and strategic thinking. What I hope to do is serve as a resource about the benefits and risks of options so that you and your clients can talk about how calls and puts might be used for diversification, protection and even opportunity.
Be sure to watch for our next Coffee With Cott blog: Overcoming the Misconceptions About Options. Do you have a topic you want to see covered in the Coffee With Cott blog? Let us know by writing to firstname.lastname@example.org.