Maz Esmailbeigi, Founding Partner and Chief Investment Officer of Alpha Summit, the third-party investment and marketing arm of SteelPeak, joined Keith Black, Managing Director of RIA Channel, to discuss increasing the income from equity portfolios while reducing downside risk.
During the global financial crisis, Esmailbeigi noticed that investors were more concerned about equity market drawdowns than declines in the value of their real estate holdings. As long as the properties continued to generate cash flow, the investors were less concerned about the price performance. Because the cash flow provided some psychological relief during short-term declines, investors believed that real estate prices would eventually recover and appreciate in the long term.
Applying the same philosophy to the equity market, Esmailbeigi seeks to generate income through dividends and options overlay strategies. Options can generate income from companies, such as Google or Amazon, that don’t pay dividends. A covered call strategy generates income from selling call options. The income generated from selling options increases with the level of market volatility. Covered call strategies tend to underperform in strong rallies, as selling call options caps upside returns at the strike price of the short option position. This strategy may cap monthly returns at 4%, combining income and appreciation of the stock to the strike price. Conversely, the strategy tends to outperform in down markets, as the income generated cushions downside returns.
Because income generated from selling call options is taxed at short-term capital gains rates, Esmailbeigi notes that covered call strategies are a great strategy to hold in tax-free or tax-deferred accounts. The investment team seeks to realize tax losses year-round, which can reduce the tax impact when positions are held in taxable accounts. When constructing portfolios, covered call strategies are typically funded from the equity allocation.
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