For probably the most part, it’s a difficult time for investors, especially for those retirees who live utilizing their investable assets, with fairly flat to negative returns from global equity markets while bond and dividend yields remain painfully dismal.
For example, the MSCI World Index has fallen to January 2014 levels and offering a paltry 2.Five percent dividend yield while closer to home the S&P TSX has returned because of October 2013 levels and offering a rather higher 3.One percent dividend yield.
For those more risk averse and searching the safety of bonds, global 120 month government bond yields currently change from negative for Japan and Switzerland, 1.36 per cent for Canada, and 1.98 percent for U.S. Treasuries.
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As investors are often reactive rather than proactive, most are actually piling into what worked this past year such as U.S. dollar denominated assets such as the S&P 500. However, the powerhouse within the U.S. equity market has struggled lately with the U.S. dollar index down 2.Five percent and also the S&P 500 down 0.75 percent this year-to-date.
We would expect a lot of same in the months later on with a fairly flat outlook for broader equity and bond markets leaving little encouragement especially for those investors based on income utilizing their portfolios.
That said, the choice market can be very effective tool this kind of atmosphere.
There are lots of different strategies you are able to deploy from straightforward put and call purchases and writes to numerous combinations with multiple-legs that could have rather cool sounding names for instance condors and butterflies.
However, to keep things simple, our favorite and many effective strategies can be a cash-covered put write. This involves selling put alternatives on the particular stock or ETF that’s backstopped with the money in a portfolio.
For example, assume ABC equity market ETF has cost of $100 per unit, so we sell a $90 six-month put option on ABC and obtain a $3.50 in premium. The portfolio gets to be a beautiful 3.5 per cent yield for the six-month period (7.0per cent annualized) that is typically taxed just like a capital gain.
Looking ahead, there are two possible outcomes according to what price ABC is trading at 6 months out.
If the ETF is trading above $90, there’s no additional transaction. The portfolio keeps the $3.50 per unit and may visit write another six-month put option for further income if desirable.
If the ETF is trading below $90, the portfolio manager is needed to buy ABC at $90 for the portfolio and the $3.50 per share in the option writing. The end result, excluding commissions, may be the portfolio now owns ABC inside an effective cost base of $86.50 which is resistant against a 13.5 per cent drop than others who owned the ETF to start with.
The strategy is loaded with lots of advantages due to the market climate, which regardless of the flat returns has witnessed plenty of volatility.
First, the majority of market corrections are between 10 per cent to fifteen percent, and this strategy, according to owning ABC outright, look after from this type of drop.
The current spike in volatility does mean one is capable of generate even higher premiums – now’s a better time to sell puts compared to a complacent market, in which it S easier to buy put protection.
Overall, the investor must be at ease with not participating past the $3.50 in premium received which may be a difficult thing to do when markets make large moves for the upside. That said, they will be happy within the flat to slightly down market with a low interest rate.
You may be wondering why more investment professionals avoid using such strategies, specially when they work perfectly.
The issue is they might need some expertise and a lot of try to track and implement something most firms don’t have the time or practical information on given their volume of clients.
It may also be much better to get investors to buy and hold a specific stock, mutual fund and/or ETF instead of notice a risk-managed option overlay program. Which might explain why most advisers have a very bullish tint on their own market outlooks.
Martin Pelletier, CFA, can be a portfolio manager at Calgary-based TriVest Wealth Counsel Ltd. twitter.com/trivestwealth
