Investors are exploring option income strategies among various alternatives to traditional income strategies. Even as yields on Treasury bills have pushed north of 5%, funds using weekly and daily expiration option strategies aiming to generate yields have captured income seekers’ imaginations. To discuss these products and options strategies, in general, the ETF Think Tank welcomed Sylvia Jablonski, the CEO/CIO of Defiance ETFs, Meb Faber, the CEO/CIO of Cambria Funds, and Jay Pestrichelli, the Co-Founder of ZEGA Financial. Each of their firms offers option-based strategies as part of their product lineup.
As for why ultra-high yield option income strategies are gaining traction now, Pestrichelli says that some investors are considering “alternative” income in an environment where bonds are experiencing steep losses. It started in 2021, but some investors saw the benefits in 2022 when they offered some downside protection in addition to the high yield. Jablonski, whose firm offers 0DTE fund strategies, adds that having these potentially costly and time-consuming strategies in an ETF wrapper helps compliance feel more comfortable and helps fill a need for clients. Faber agrees that options can be a big pain for investors, especially advisors with hundreds of clients. Today, you can get pre-packaged option strategies and pick the product that works best for you.
Current 5% yields on Treasury bills have been a point of interest for many investors that may feel like they’ve won the lottery. Options strategies still offer benefits because the return paths can be very different relative to other asset classes. Jablonski notes that even if interest rates go back to 2-3%, options income strategies may continue to be attractive because the high yields are still obtainable. With inflation still lingering in the background, the potentially faster turnaround of income with options can be a big advantage.
While most people think of covered call strategies using equities, the yields on fixed income covered calls have the potential to be substantial, according to some investors. Faber says that there’s a generation of younger people discovering things for the first time – 7-8% mortgage rates, 5% Treasury bill yields and nearly two years without a record high in the S&P 500. Investors are beginning to realize there’s an ocean of investments available, especially in the bond market. With so many different types of bonds out there – sovereign, corporate, TIPS, etc. – there’s an element of people not really understanding the flavor of bonds, but it’s getting more attention now.
All three panelists agree that covered call strategies work best when distributions are reinvested. It’s not a “set it and forget it” strategy. You want to maximize the income capture and the compounding effect. The pile of cash from premium income isn’t doing anything for you if you don’t reinvest it. You need to put it back to work.
Other key takeaways:
- Over the past couple of years, option strategies have emerged as a good portfolio alternative when stocks and bonds remained tightly correlated. The aim for these investors is to find strategies that might offer diversification benefits and potential yield.
- Options strategies are an opportunity to leverage volatility and that makes earnings season an enticing time of year. Pestrichelli says that this absolutely impacts how you use options and sometimes you can get as much as a couple weeks of volatility to take advantage of.
- Faber explains that a lot of people two years ago thought that the max drawdown in bonds was around 10%. They’re learning reality the hard way now. Historically, the yield curve has been fairly predictive. An inverted curve often works for T-bills & gold. A normal curve works for stocks. A steep curve works better for REITs.
- A piece of advice from Pestrichelli – You have to consider your worst-case scenario first. Manage your risk.
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