More financial advisors are opting for options.
A recent Options Industry Council (OIC) survey reports that 61% of advisors are using options, up from 48% in 2011. Calls, especially covered calls, are the most requested options, says the survey, and the most common reason for using options is to generate income.
With a covered call strategy, investors get income by selling options to buy securities they own at a given price during a certain time period.
"The potential to add income on existing holdings is the reason the covered call can be considered the go-to strategy," says Eric Cott, director of financial advisor education at the OIC. "Covered calls are one of the more basic strategies, and are easy to recommend, especially when clients are seeking alpha in a zero-interest-rate environment."
More firms are allowing advisors to use options-based strategies, according to Cott, which explains the greater use of covered calls. "The concept is like renting a stock or an ETF and earning income from it," he says. "This creates the ability for a client to collect premiums, and it's a great way to set a targeted selling price."
Arden Hills, Minn.-based Gradient Investments offers a covered call portfolio to independent RIAs. The firm's chief investment officer, Wayne Schmidt, suggests that advisors draw a parallel to rentals in explaining covered calls to clients. "An advisor might say that selling calls on the ETFs you own is like 'renting' your investments," he says. "Someone can buy your ETFs at an agreed-upon price, generally within 30 days. For that right, the buyer pays a monthly sum. You keep the rent and you may have to sell if the ETFs reach that price."
According to Cott, some advisors manage their clients' assets directly, implementing the trades necessary to execute their options strategies. Other advisors don't want the task of managing positions daily, preferring to focus elsewhere. In that case, Cott says, an advisor "can act as a general contractor and sub out the role to an overlay manager who will handle the implementation."
QUALITY & VOLATILITY
Schmidt says he uses ETFs that have a deep options market. "These are the more liquid and actively traded ETFs," he says. "We want to own ETFs that might perform best from a total return standpoint, and also have enough volatility to generate meaningful option income."
As Schmidt notes, many clients have watched their investments fall, come back, and drop again. "It is very hard to know when to sell," he says. "Using covered calls can help to eliminate the fear and greed that sometimes ruin an investment strategy."
Donald Jay Korn is a Financial Planning contributing writer in New York. He also writes regularly for On Wall Street.
This story is part of a 30-day series on Social Security and retirement income strategies.