Options strategies remain a popular choice with advisors and investors for the benefits they bring to portfolios. For those seeking to enhance their equity allocations, Parametric and Morgan Stanley Investment Management offer two ETFs with differing options strategies and outcomes.
Option Investing 101
While options are more common now than a decade ago, they remain a somewhat opaque area of investing for many. It’s no surprise, given the wide range of options available, and their variety of use cases.
Parametric focuses on the two core types of options most used in ETFs: covered calls and protective puts. A covered call entails holding an underlying asset while writing a call option on it. It’s used in options strategies to generate premiums. A protective put, on the other hand, holds an underlying asset and then buys a put on it to protect against downside risk. Any potential losses are capped at the put strike price.
Options may also be in the money or out of the money. This is relative to the current underlying stock price. An in-the-money option means the stock price has passed the strike price, while out-of-the-money means it has yet to reach the strike price. Out-of-the-money options are generally cheaper because they offer no intrinsic value at their current position.
Some strategies take this a step further and use options ladders. This eliminates single-option risk by creating a variety of positions at various strike prices. It also creates a level of potential flexibility for the underlying portfolio across the options positions. Options ladders may also allow for a strategy to balance income with a desired outcome, such as downside protection.
Parametric Offers Income, Downside Hedge Options ETFs
The Parametric Equity Premium Income ETF (PAPI) offers investors the dual benefit of active management alongside reliable equity income in challenging market environments.
PAPI seeks consistent monthly income as well as capital appreciation. The strategy does so by investing in an actively managed portfolio of dividend-paying equities chosen from the Russell 3000. It does so by using top-down, systematic analysis to select quality companies.
Companies included demonstrate 12 months of high current income and reduced risk within their sectors. The quality equity portfolio is also diversified across sectors, with sectors equally weighted.
The fund also employs an options strategy that writes short-dated, laddered, out-of-the-money calls on the S&P 500. The laddered calls generate premiums as well as allow for more upside appreciation potential compared to a single call option position.
PAPI carries an expense ratio of 0.29%,
See also: “PAPI’s Systematic Income Options Strategy Benefits Investors”
Investors looking to mitigate potential equity drawdowns should consider the Parametric Hedged Equity ETF (PHEQ). The fund seeks to provide capital appreciation while protecting against losses.
PHEQ invests in U.S. large-cap stocks within the Solactive GBS US 500 Index while utilizing options to hedge against drawdowns. The strategy optimizes the weights of its holdings to create a risk and return profile similar to that of the Index.
It also employs a laddered options overlay strategy that sacrifices some upside potential for downside protection. PHEQ does so by utilizing a put spread collar strategy wherein it buys close to the money protective puts and sells further out of the money puts.
Any loss mitigation is limited to that which the put spread covers. The fund ladders the one-year options across quarters to allow for optimal downside protection and upside capture. The fund also writes calls, thereby earning a premium to offset the put spreads.
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