In an Index Income Strategy, Optimism and Patience are at a Premium

index income strategy requires long-term strategy and patience

In an Index Income Strategy, Optimism and Patience are at a Premium

Investment clients who are bearish on equities—or who do not have the patience to wait through market corrections—need not apply, at least not for becoming invested in the Sheaff Brock Investment Advisors Overlay Strategy. That’s because this particular strategy is intended for long-term, time-premium capture strategy, and is not a trading strategy designed for quick gains.

How does the strategy work? For each of three subsequent months, portfolio managers:

  1. Sell put options on an S&P 500 ETF (exchange-traded fund)
  2. Buy long “insurance” puts with a strike price 15% lower

“This is not a trading strategy,” Sheaff Brock cautions. What is it, then? Answer: a premium decay strategy, with low trading activity. You must be patient, willing to “push risk forward in time, until the stock market recovers.” Considered an alternative income source, selling put options can be an effective way to add cash flow (and the potential for capital gains) to an account; however, it is likely to be effective only for investors who understand the potential risks of the strategy (potential for capital loss) and can maintain both general market optimism and healthy doses of patience.

To mitigate at least a portion of the risk, Sheaff Brock portfolio managers have been:

  1. Using Standard & Poor’s 500 Index options, exposing clients to the market as a whole, rather than to selected individual companies, and
  2. Keeping the put option exposure at or below 15% of the value of the client’s collateral account,

as Dave Gilreath, managing director of Sheaff Brock and manager of the Sheaff Brock Index Income Strategy explained to our SheaffBriefs editor. Still, he cautions, clients are layering on stock market risk to their accounts, and must be willing to accept any of three possible outcomes:

  • Remain with the strategy throughout a downdraft and possible commensurate recovery—offering the potential for realized gains.
  • Close the account during a downdraft—losses will be realized.
  • Stay through the stock market collapse from which the market never recovers—you could lose as much as 15% of the account.

When it comes to achieving success with an index income strategy, only the “right investors” (those with optimism and patience) need apply!

To review our disclosures about the purposes and risks of option transactions, click here.

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