Investing During Volatile Periods
“The idea that a bell rings to signal when investors should get into or out of the market is simply not credible. After nearly 50 years in this business, I do not know of anybody who has done it successfully and consistently.”
The memorable adage from John C. “Jack” Bogle, founder of Vanguard, is more relevant than ever as we head into the second quarter of 2018. Over the course of Q1, many investors found themselves re-examining their investment strategy and succumbing to portfolio decisions driven by emotional distress brought on by fluctuations in the market.
Often times during periods of heightened volatility, calmer heads tend to prevail as overreaction can lead to unwarranted trading during short-term periods of market volatility. Just because the market starts to dip doesn’t mean that one should rid themselves of standing allocations. As a market participant it is pivotal to ask the question, “has anything changed with the story surrounding that security or allocation?” If not, why sell just because the market is going through a volatile period?
Outside of capturing and incurring losses along with tax implications due to trading, investors have a lot to consider while navigating through choppy markets. However, there are a number of tools for investors that can potentially minimize variance and help generate a measure of downside protection. One such tool are exchange traded funds that use options strategies like the covered call ETF suite offered by Horizons ETFs U.S.
Horizons ETFs U.S. offers the largest family of covered call ETFs in the country. The Horizons Nasdaq 100 Covered Call ETF (Nasdaq: QYLD) and the Horizons S&P 500® Covered Call ETF (NYSE Arca: HSPX), which both pursue a strategy that offers investors potential monthly income with lower volatility than the funds’ underlying indexes. These funds aim to complement investor’s current equity and income investments.
The following three tips on call options and ETFs that use options can be considered by investors and advisors looking to navigate markets.
01. Volatility can equal opportunity
In instances when volatility rises, an investor can potentially benefit by introducing funds that use option strategies into their portfolio. Although sometimes seen as highly sophisticated and hard to understand, options strategies can be easily implemented and used by a fund manager to help provide a measure of protection to their current holdings. One way a fund manager may harness option strategies is through the use of call options. If the fundamental view of a company hasn’t changed but the current market environment shows signs of volatility, the Fund’s manager could potentially gain a measure of downside protection as well as help generate income through selling a call option on their current stock holding. However, writing covered calls limits the update potential of other underlying security.
02. Stand tall, think about selling a call
Selling a call option can be used to potentially provide investors with a measure of downside protection, but it’s important to note that writing call options can also limit the upside potential of the underlying security.
Say a fund manager owns 100 shares of company “ABCD” and sells one call option on the 100 shares they own. In return for selling a call option on company “ABCD,” which gives the fund manager the right but not the obligation to buy 100 shares of company “ABCD” at a predetermined price in the future, the fund manager receives a premium.
The key element to note is that the amount of options premium received for writing a call option is directly linked to market volatility. Historically as volatility rises, so too does the level of premium that can be generated from writing a call option, thereby potentially offering a greater measure of downside protection. Exchange traded funds (ETFs) that utilize different options strategies and eliminate the call writing work for the individual investor are also an option. Many of these ETFs take a broad-based index approach where they own U.S. equity benchmarks, such as the S&P 500 or the Nasdaq 100.
03. Don’t be afraid and keep long-term goals in mind
As an investor, it’s important to take long-term goals into consideration before making any sudden changes in one’s portfolio construction. It’s understandable that many investors may still have scars from the tech bubble in the early 2000s and the global financial crisis in 2008. At times when volatility rises and markets are moving hundreds of points a day, it can be very challenging for investors to remain calm and maintain focus on their long-term investment objectives.
With factors of increased market volatility as well as growing geopolitical instability seen throughout Q1, investors face new and uncertain market dynamics. As markets continue to evolve, so too must investors. The use of ETFs that employ options can potentially benefit a portfolio in a multitude of ways during periods of lowering markets. If one were to take a historic look at markets they would find that as volatility rises, equity markets tend to move lower. However, the premium received from call writing increases, which may help lower overall portfolio volatility. In the event of continued market uncertainty, investors can find new ways to navigate markets by looking beyond the traditional tool box as they strive to achieve their specific investment needs.
© 2018 Horizons ETFs Management (US) LLC. All Rights Reserved.
Before investing you should carefully consider the fund’s investment objectives, risks, charges and expenses. This and other information is in the prospectus, a copy of which may be obtained on this website. Please read the prospectus carefully before you invest.
There are risks involved with investing, including possible loss of principal. Concentration in a particular industry or sector will subject the funds to loss due to adverse occurrences that may affect that industry or sector. Each sector fund is subject to its own specific risk factors. See prospectus for specific risks regarding fund. Investors in the funds should be willing to accept a high degree of volatility in the price of the fund’s shares and the possibility of significant losses. International investing involves risks, including -risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks often are heightened for investments in emerging/developing markets or in concentrations of single countries. Diversification may not protect against market risk or loss of principal. DAX and QYLD are considered non-diversified and may be subject to greater risks than a diversified fund.
QYLD and HSPX both engage in options trading. An option is a contract sold by one party to another that gives the buyer the right, but not the obligation, to buy (call) or sell (put) a stock at an agreed upon price within a certain period or on a specific date. A covered call option involves holding a long position in a particular asset, in this case U.S. common equities, and writing a call option on that same asset with the goal of realizing additional income from the option premium.
QYLD engages in writing covered call index options on the Nasdaq-100 Index and HSPX engages in writing covered call index options on the S&P 500® Index. By selling covered call options, the fund limits its opportunity to profit from an increase in the price of the underlying index above the exercise price, but continues to bear the risk of a decline in the index. A liquid market may not exist for options held by the fund. While the fund receives premiums for writing the call options, the price it realizes from the exercise of an option could be substantially below the indices current market price.
Horizons ETFs Management (US) LLC is the investment adviser of HSPX, DAX, QYLD, and USDY. The funds are distributed by Foreside Fund Services, LLC, which is not affiliated with Horizons ETFs Management (US) LLC or any of its affiliates.
Individual shares of the horizons-branded exchange traded funds (the “funds”) may be purchased or sold in the secondary market throughout the regular trading day on the New York stock exchange or Nasdaq exchange through a brokerage account. Brokerage commissions will reduce returns. However, shares are not individually redeemable directly from the funds. Each fund issues and redeems shares on a continuous basis, at NAV, only in blocks of shares (“creation units”), principally in-kind for securities included in the relevant index. The creation units for DAX, QYLD, HSPX, and USDY are 50,000 shares.