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Investment Process - Options
In today’s volatile environment portfolios need to be flexible and dynamic, able to withstand downturns and be positioned to take advantage of them. Your investible assets are your life’s work and rather than depending on an asset manager’s promise to side step a bear market we choose to prepare ahead of time. By utilizing options we can construct a predefined downside strategy at a fraction of your overall portfolio value so if the markets continue to increase in value you can benefit from that positive appreciation!
This is crucial in meeting your long term investment goals as downside volatility curtails compound returns and increases the likelihood of behavioral mistakes which can devastate long term returns.
The chart below illustrates the sizeable benefits of using a predefined downside strategy in your portfolio. Over a thirty year period if you originally invested $1 million in a portfolio utilizing a predefined downside strategy you would have ended with an additional $5.9 million or 37.8% more assets than a traditional portfolio management approach*.
Portfolio Values (USD):
*Data source: S&P 500 index total returns from Yahoo Finance & Robert Schiller. Starting portfolio value of $1 mill over 30 year period from 1921 – 1951. When yearly analysis was lengthened from 1921 through 2009 (latest yearly data available) absolute value of the portfolio using a predefined downside strategy would have exceeded that of traditional portfolio management by approximately 20%. Portfolio returns assumed equal management fees and the cost for the predefined downside strategy was assumed to be 1%.
Like other asset classes, the investment approach for options require careful analysis. However, the analysis is slightly altered as these securities have different input variables:
Analysis:
- Valuations -- Are options trading at a discount, in-line or at a premium? We will look at relative valuations versus history, peer analysis and intra-security metrics
- Market Outlook – Our market outlook plays a large part in determining volatility allocation as direction has an impact
- Term structure – Relative valuation analysis of options in different time frames (e.g. March options versus April options)
- Interest rate outlook – Interest rates impact option pricing (higher interest rates = higher call option values)
- Dividend outlook – Dividends also impact pricing of options (higher dividends = higher put option values)
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Learn why Fourth Quadrant Asset Management may be right for you:
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