The Wall Street Journal had a nice article about using a covered call strategy which Zeke Ashton of the Tilson Dividend fund employs.
If you think markets are likely to be pretty flat or slowly rising (which I think many do) this can be a pretty rewarding strategy. The key is to stick with high quality companies that you will be comfortable holding for a long time if the world falls apart.
At a time when investors are caught between meager interest rates on savings accounts and worries about whether the recent stock-market run-up can continue, funds using options to generate extra income or cushion against losses, or both, are gaining attention.
One of the most popular approaches involves "covered calls," a strategy in which an investor β in this case a fund β generates extra income by selling to another investor the right to buy some of its stock holdings at a set price, if the shares rise above that price by a set date. In essence, the fund is getting more dollars today in exchange for giving up potential gains down the road. Other options may be used simultaneously to limit downside risk.
"We think the [stock] market has experienced most of the gain for the year already and is probably going to see more volatility, so this strategy makes a lot more sense at this point" than in some other environments, says Tyler Vernon, chief investment officer of Biltmore Capital Advisors, Princeton, N.J., which has $600 million under management.
Possible Outcomes
A covered-call strategy typically works best when the market is rising gradually or relatively flat, so the income collected from the option sale exceeds any potential gains that may be forfeited.
If the stock against which a call is written doesn't rise above the strike price by the agreed-upon date, the fund pockets the extra income from the option sale and gets to hang on to the shares, too. If the stock rises above the price within the agreed-upon time, the fund hands over the stock to the option buyer, forfeiting any future gains, but gets to keep the income from the option sale. Of course, if the stock plummets, the fund is left holding the stock β and the loss β although it is reduced somewhat by the income generated from the option sale.
The highest premiums from selling covered calls typically come from owning the most volatile stocks. "Because you have full exposure to the downside and are capping the upside, you have to be careful to buy high-quality businesses," says Zeke Ashton, who manages Tilson Dividend.
Options come with their share of risk, so analysts urge investors to stick with fund managers who have a good track record using them and caution against being wooed by high yields without digging deeper.
Not every fund manager uses the same options strategy. Some sell covered calls on a broad index, while others write them on individual stocks, which can be riskier. Others buy put options, or the right to sell, in conjunction with the covered calls to reduce the risk from a market decline.
Here is a look at some funds using covered calls:
The entire piece is available here.
If you think markets are likely to be pretty flat or slowly rising (which I think many do) this can be a pretty rewarding strategy. The key is to stick with high quality companies that you will be comfortable holding for a long time if the world falls apart.
At a time when investors are caught between meager interest rates on savings accounts and worries about whether the recent stock-market run-up can continue, funds using options to generate extra income or cushion against losses, or both, are gaining attention.
One of the most popular approaches involves "covered calls," a strategy in which an investor β in this case a fund β generates extra income by selling to another investor the right to buy some of its stock holdings at a set price, if the shares rise above that price by a set date. In essence, the fund is getting more dollars today in exchange for giving up potential gains down the road. Other options may be used simultaneously to limit downside risk.
"We think the [stock] market has experienced most of the gain for the year already and is probably going to see more volatility, so this strategy makes a lot more sense at this point" than in some other environments, says Tyler Vernon, chief investment officer of Biltmore Capital Advisors, Princeton, N.J., which has $600 million under management.
Possible Outcomes
A covered-call strategy typically works best when the market is rising gradually or relatively flat, so the income collected from the option sale exceeds any potential gains that may be forfeited.
If the stock against which a call is written doesn't rise above the strike price by the agreed-upon date, the fund pockets the extra income from the option sale and gets to hang on to the shares, too. If the stock rises above the price within the agreed-upon time, the fund hands over the stock to the option buyer, forfeiting any future gains, but gets to keep the income from the option sale. Of course, if the stock plummets, the fund is left holding the stock β and the loss β although it is reduced somewhat by the income generated from the option sale.
The highest premiums from selling covered calls typically come from owning the most volatile stocks. "Because you have full exposure to the downside and are capping the upside, you have to be careful to buy high-quality businesses," says Zeke Ashton, who manages Tilson Dividend.
Options come with their share of risk, so analysts urge investors to stick with fund managers who have a good track record using them and caution against being wooed by high yields without digging deeper.
Not every fund manager uses the same options strategy. Some sell covered calls on a broad index, while others write them on individual stocks, which can be riskier. Others buy put options, or the right to sell, in conjunction with the covered calls to reduce the risk from a market decline.
Here is a look at some funds using covered calls:
The entire piece is available here.
