Meanwhile, stock investors are concerned about the impact of market volatility on their portfolios.
For some investors, the solution to both problems may lie in options strategies long used by professionals and sophisticated individuals.
The complexities of executing options — contracts for the prospective sale or purchase of specific stocks during a set time period — makes them inaccessible for most individual investors. But over the past few years, a variety of options-based exchange-traded funds have come on the market. This has afforded individuals easy access to various options strategies to produce income, hedge risk or both.
traded funds have come on the market. This has afforded individuals easy access to various options strategies to produce income, hedge risk or both.
Option-based ETFs are geared to either hedging (protecting investors from losses in a down market), or providing supplemental income to another investment strategy.
For hedging, they often use put options, which give shareholders the right to sell the underlying stocks at a preset price if the actual price falls below that threshold. For supplemental income, they often use puts or calls, option contracts giving the owner the right, but not the obligation, to buy a specified amount of an underlying security at a preset price within a specified time frame.
The introduction of about 120 such ETFs in the past few years has taken this category from an obscure corner of the market to a highly visible place. Adoption has been rapid amid a search for income that has intensified as real bond yields (net income after inflation) have dipped below zero.
Options-based ETFs are gaining traction as investors struggle to reconcile high stock prices and historically low bond yields. To that point, inflows into options ETFs so far this year are estimated at more than $8 billion. ETFs designed for hedging alone posted inflows totaling about $5 billion for the 12 months ending Aug. 31 — an indication that many shareholders are using these products for risk protection.
For many individual investors, the rationale of these products may seem counterintuitive because they see volatility as being synonymous with risk. Yet well-conceived, well-executed options strategies can actually reduce risk.
ETFs vs. hedge funds: How derivatives could change market dynamics
True risk is the chance of permanent loss of capital. Despite their general reputation for safety, this is possible with bonds. Though stocks are called “risk assets” because of their volatility, this fluctuation in value creates opportunity for both