In 2011, the Options Industry Council (OIC) conducted a national study of options usage among advisors. It was called the?Financial Advisor Benchmark Study and Bellomy Research oversaw it.?
OIC released the findings on May 12, 2011. One highlight was advisors who?used options in their clients? portfolios had larger, more successful practices. OIC also also learned that many advisors would like to add options to their practice, but don?t know how or where to begin.
To further delve into the information gleaned from advisors in the study, OIC?identified 10 advisors who have been successfully using options in their practices and then interviewed them on how they do it.
The findings are in a new white paper called, “Tales from the Front – How Advisors Successfully Use Options in Their Practices.”
From the additional findings, OIC discovered the advisors shared similarities in how they viewed their practices and how they went about introducing and managing options with their clients. They also learned why they use options, how they talk about options with their clients, and how they fit options into their busy schedules.
Here at the Options Insider, we’re going to share these findings with you over the course of a few different posts. We’ll start with the section,?WHY THEY USE OPTIONS AND THE?STRATEGIES THEY FAVOR.
Although risk management was the leading reason advisors?used options, several other reasons came up in the course of the?interviews; enhanced income, portfolio ?diversification, reduced?volatility, and a way to move clients off the sidelines.
- ?From an income standpoint, especially in this environment, the things I can do for clients with options, nothing else can touch.?
- ?We have a large number of executive clients who had the largest proportion of their net worth in one listed security; we?ll use call writing as a way to scale out of that position over time.?
- ?In writing covered calls and writing them in a disciplined way you lower the volatility of the portfolio. That?s my other goal.?
- ?We had a lot of clients who were on the sidelines with cash, new prospects with cash, and they were leery about getting into the market. But if we told them we could get them into the market and hedge some of that downside risk, they were much more apt to come on board.?
All of the advisors interviewed use covered call writing, where a call?option is written against an equal amount of stock. The premium?provides additional income, although the stock can be called away if?the strike price is reached.
- ?We primarily sell covered calls. That is the easiest strategy to explain to clients and it?s the one that we use more than any other.?
Buying puts or selling cash-secured puts were also mentioned by several advisors. Buying a put helps to protect the value of a stock in the case of decline. In the case of selling a cash-secured put, the put seller sets aside the cash needed to purchase the underlying shares at the strike price if assigned, but keeps the premium for selling the option if not assigned.
- ?We do some purchasing of puts for hedging purposes, to protect larger positions. We sell puts in some clients? portfolios that are very aggressive. When we do that the clients must be very comfortable owning the stock at that certain price.?
Collars are a popular strategy, often used to protect a single stock position. In a collar, a written call and a long put are taken against a long stock position. The options may have the same strike price or different strike prices and the expiration months may or may not be the same.
- ?The collar strategy usually gets people?s attention because it?s a unique solution that isn?t offered everywhere. Let?s say you have a prospect that?s had a million dollar single stock position for 15 years. Everyone else is asking him if he is ready to sell and you can say ?You can keep your stock. We?re going to trade around your position with the goal of hedging against market crashes in an effort to make premium above and beyond the dividend.?
Occasionally these advisors implement spreads. A spread is any strategy composed of two or more legs, one long option and one short option, of differing strikes on the same underlying.
- ?We do covered calls, hedge puts, collars, and then, personally and with one client, we?ll do spreads. He?s a slightly more aggressive investor, and?I opened my big mouth. When he found out I was doing it for myself he was fairly adamant about doing it for him too. I was very reluctant but, so far, so good.?
A variation on spreads is the horizontal spread which usually means the purchase of a farther-term option (call or put) and the writing of an equal number of nearer-term options of the same type and strike price.
- ?We?re using mostly horizontal spreads?which is buying the back month and then selling the front month against it, which makes it horizontal. That?s how floor traders generally trade, and that?s how we?ve evolved our strategy. We use horizontals because it has the least amount of margin requirement. It also has generally the best win-loss ratio? And there?s mis-pricing, generally, between long dated and short dated options. There?s also a time value erosion benefit when you own the long and sell the short. So that?s that in a nutshell.?
At least one advisor in the group also uses LEAPS, (Long-term?Equity AnticiPation Securities) LEAPS are calls and puts with expirations as long as thirty-six months.
- ?I use covered calls, protective puts and long call LEAPS. With the volatility in some of the LEAP options I felt there was the potential to generate above-average returns for a portion of some of my clients? monies.?