Derivatives Portfolio

These strategies are generally linked to liquid ETFs and offer protection, upside exposure, or yield generation. They are all forms of protective puts or covered calls and are implemented with exchange-listed options. Other strategies are available. All strategies are based on client needs and will be discussed in-depth before implementation to determine suitability and to ensure all risks are understood.

A. Hedged Equity strategy protects a range of downside for a referenced asset in exchange for selling the upside beyond a certain percentage (for example, protect the first 15% of downside and cap the upside at 20%). The ranges are chosen to minimize the up-front cost of the options and depend upon market conditions. There is a tradeoff between the range protected on the downside and the amount of upside exposure the client retains. Most favorable expiration term is 12-14 months.

B. Portfolio Protection strategy provides a gain if the referenced asset falls in price, in exchange for an initial payment of premium. This strategy is implemented when the client is worried about the overall level of the market. Clients retain their stocks but are willing to invest some money to protect against a market sell-off in the short-term. Generally, we either choose SPY or QQQ as a reference asset, use a term of 2-3 months, and use a downside range of 10-15%. We target a strike range where the payoff will be 4-5x amount paid up-front for the options, in the case of a market selloff that covers the entire range.

C. Market Recover strategy provides double upside exposure in the referenced asset for times where the market is in oversold conditions. This is a short-term strategy where the client buys an ETF, and then buys a short-dated ratio call spread referencing the same ETF. The ratio is a buy of one call and a sale of two calls, choosing an upside strike which makes the initial cost close to zero. The client is long the stock to the downside, double-long the stock in the upside range, and then flat (no position) above the higher call-spread strike. Client retains full downside exposure.

D. Yield-enhancement is the most common strategy used by both institutional and retail investors. It consists of buying a core asset which will be in the portfolio for a long time, and then systematically selling, or “writing”, shorter-dated call options against this position. Typical maturity is 2 months and strike around 4% above the current spot. Idea is to continue to write new calls every time the previous call expires, and to collect the option premium from the sold calls throughout the year. NOTE: This strategy will underperform a simple long stock position in a fast-rising market.