Jeff Chang, President of VEST, joined Keith Black, Managing Director of RIA Channel, to discuss buffered ETFs and hedged equity strategies.
Many investors think that asset allocation and diversification are synonymous with risk management. The volatility of, and correlation between, stocks and bonds are not constant. As rates rose in 2022, stocks and bonds simultaneously lost value, leading to a rising correlation between the two assets. This rising correlation left many investors disappointed in the power of bonds to diversify a stock portfolio.
As a result, investors are rethinking risk management to consider adding hedging strategies. Equity hedging strategies, such as the purchase of put options, have a reliably negative correlation to stocks. Contrary to prior implementations of buffered strategies in structured products or annuities, investors own the exchange-traded options held in buffered ETFs, which moves investors away from the credit risk of the bank or insurance company.
Investors’ need for income doesn’t change with the level of market volatility that determines options prices. A target-income covered call strategy can be designed to have a relatively stable income stream, such as 8% over the dividend yield on the S&P 500. To reach this income target, fewer call options will be sold in higher volatility environments, while more call options will be sold in lower volatility environments. Selling options with weekly expirations can maintain a greater portion of the upside return as investors more premium per time period when selling shorter maturity options.
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