Option premiums should be viewed not as a yield replacement, but as more of an alternative equity product with much different risks than those associated with fixed income. While one is correlated to interest rates, the other is correlated to the equity markets.
It is important to remember that all options strategies are not created equal. The challenge for advisors is really in understanding how certain strategies perform in certain environments. Managers using them in a very opportunistic way will experience much different performance than those who are following a recipe.
Many options strategies are particularly methodical and put on new positions every 30 or 60 days as expirations occur. But this may be less than optimal. By truly understanding when an options strategy is providing benefit and when it is not, managers have the flexibility to view the world from a volatility perspective first and foremost.
As the fixed income allocation in many portfolios is dialed down, advisors might want to consider adding an options strategies bucket to arrive at a 60/20/20 allocation. This could also mean an 80 percent allocation that includes correlated alternative equity strategies along with straight stocks, matched with a 20 percent fixed income allocation. For those wanting to include alternative investments in a typical asset allocation, options strategies can now be accessed in the very liquid form of a mutual fund, an approach that offers a less volatile option than a pure long-only equity mutual fund.
It’s clear that the traditional allocation model has become an anachronism. It’s also clear that a new core allocation taking advantage of options strategies along with stocks and fixed income can provide significant benefits to troubled investors in today’s financial world.
Eric Metz is Portfolio Manager and Derivatives Strategist for RiverNorth Capital Management, LLC, a leading investment management firm specializing in opportunistic investment strategies.