Option Premiums Can Provide Additive Returns During the Elevator Ride

Taking the elevator down | option overlay for returns | Sheaff Brock

Option Premiums Can Provide Additive Returns During the Elevator Ride

“Stocks often take the elevator down and the stairs up,” Sheaff Brock Managing Director Dave Gilreath comments, referring to the strong rallies following the stagnant markets in 2004–2005, 2011–2012, and 2015–2016. “The stock market often takes a breather before rallying up to a higher plateau,” Gilreath adds. With the Dow Jones “stuck” for the past year-and-a-half, he observes, it’s not unreasonable to anticipate another “stair-climbing” period.

Chart showing Dow Jones Industrial Average rally in 2004-2005

Dow Jones Industrial Average 2011-12

Chart showing Dow Jones Industrial Average 2015-2016

In an earlier First Trust Monday Morning Outlook report, Chief Economist Brian S. Wesbury, had some “stair-climbing” comments of his own that are still relevant: “As the summer goes on, we expect evidence will continue to show that the economy isn’t slipping into recession.” Wesbury makes note of several positive factors presently in play:

  • home building has room for further growth
  • household debt relative to assets is low
  • banks are in strong financial shape
  • corporate debts are below normal relative to assets

Looking back at those three examples of strong rallies following stagnant markets, Gilreath points out that those represented respective gains of 25%, 35%, and 45%, In contrast, our DJIA “stair-climb” would need to rise only 15% to hit the 30,000 level. Needless to say, Gilreath cautions, “nobody has the slightest idea what the market will do.”

Meanwhile, he notes that spikes in volatility such as the one in May can serve as a cash-flow benefit in option overlay strategies. Sheaff Brock offers two option overlay strategies, Index Income and Put Income.

The Index Income Overlay seeks to generate additional income through the sale of put options on an S&P 500 ETF. In the Put Income Overlay, puts are sold on high-quality equities to generate additional income, using a concentrated equity position, bond portfolio, or other equity portfolio as collateral. These option overlay strategies are appropriate for investors who are comfortable with taking additional stock market risk with an opportunity for added cash flow.

Whether or not we’re firmly set to continue a stair climb, it’s worth noting that during the recent downward “elevator ride,” option premiums can help provide additive returns.

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