Timely vs. Timeless—Option Overlays Strive to Be Both

Option Overlay Strategies as Timely and Timeless | Sheaff Brock

Timely vs. Timeless—Option Overlays Strive to Be Both

With this month’s over-arching message being the power of TIME—the goal being to discuss investment tactics which are timely, yet which belong in portfolios based on timeless wisdom—the option overlay strategy becomes a particularly relevant topic.

There’s nothing new about option overlays. In fact, as Institutional Investor explains, the majority of U.S. pension plans have adopted overlay techniques as part of their investment tactics. And, while in investment vocabulary, the term “overlay” can have different meanings, Sheaff Brock Managing Director Dave Gilreath offers a straightforward definition: the use of derivative investments with an underlying securities portfolio serving as collateral.

“Asset allocation is like a car with four-wheel drive,” an article in the Orange County Fire Authority Deferred Compensation Plan newsletter explains. While four-wheel drive is not guaranteed to prevent your car from slipping, having it could be a protective tactic—you have a better chance to gain traction. As investors sense the advent of a period of higher market volatility, it may be timely to incorporate portfolio tactics such as overlays.

The “four-wheel drive” aspect of option overlay strategies comes in the form of income. The intent is, by being a seller (writer) of options, rather than a buyer, it may be possible for an investor to generate conservative, repeatable, incremental monthly yield from assets that would otherwise have little or no cash flow.

This is the very concept underlying Sheaff Brock’s Option Overlay strategies, meant for clients with:

  • a long-term mindset
  • a large, monochromatic position in a single security or in muni bonds
  • an upward bias—belief that the market will grow, or at least maintain, its overall worth in the future
  • a desire to potentially increase income in exchange for higher exposure to volatility

Sheaff Brock’s primary Option Overlay strategy is:

Index Income OverlayA put option credit spread is created on an S&P 500 ETF to generate additional income. A short put is sold, usually 3% out-of-the-money, and that option is paired with a long ‘insurance’ put, usually with a strike price 15% lower.

Option overlay strategies are very timely, Dave Gilreath notes, given recent increases in market volatility.

In another sense, option overlay strategies are also timeless. For many decades, while perhaps feared and misunderstood by the masses, options have been employed by those with general market optimism and healthy doses of patience striving to achieve long-term improvement of risk-adjusted returns.

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