Eric Cott thinks 2018 may end up being a difficult year for equity investing, and he wants advisors to know they have options.
Cott, director of financial advisor education for the Options Industry Council, said that advisors were approaching him with worries about more volatility in the markets before the year began.
“With volatility more on their minds and their clients becoming more concerned about tariffs and trade and what’s going on internationally, we’re seeing more peaks and troughs in the market,” he said. “We had not experienced major fluctuations between 2009 and 2018, but advisors’ mentalities are shifting to be a bit more defensive.”
Investor interest in options is never low, said Cott, but until recently, buoyant, momentum-driven equity markets have made most advisors emphasize inexpensive passive index strategies. Proposed fiduciary regulations had also made more advisors emphasize the simplicity of long-only equity investing.
Cott, who will speak at the 9th Annual Inside Alternatives and Asset Allocation conference from Sept. 24 to Sept. 25 at the Wynn Las Vegas, said that advisors’ interest in options and options strategies has increased as volatility has increased somewhat this year.
“That’s why options are wonderful. When you look at the long strategy of an equity, there are three potential outcomes: It goes up, it goes down or it stays flat,” he said. “We have no idea what will happen. You’re hoping that the company reports good earnings and that everything is rosy, but with options you can overlay an alpha-generating component.”
Calls
One popular strategy to create income during volatile and sideways-moving markets is selling covered calls, said Cott. As interest rates bottomed out, many investors have sought additional income from their portfolios by selling covered calls on dividend-paying stocks.
“From March 2009 to early this year, advisors were sort of looking at the covered call as a way to enhance the returns of a position,” he said. “Add a little bit of income, sell a call out of the money and look to provide income generation while you’re waiting for the stock to go up.”
Other investors replace some or all of an equity allocation with call buying to capture gains while limiting their losses, but they run the risk of buying out-of-the-money call options and losing their positions entirely, said Cott.