Investors can use options to prevent large downside market declines, says Dino Bourdos, a managing director with TD Asset Management.
Speaking at the firm’s Sharing of Knowledge Learning Series 2015 in Toronto on Wednesday, he described an options strategy that preserves capital but also may limit returns in a strong equity market.
“We buy put options because we need the insurance. But we don’t just buy the put option,” he explained. “We need to collect premiums to cover the cost of that insurance. What we do is sell covered calls and that limits how much of the upside we’ll participate in.”
He prefers using shorted dated calls.
“By resetting those calls more regularly, we can write calls slightly more than where the market’s trading at and still capture a decent amount of the upside,” Bourdos said.
This strategy provides investors with exposure to stocks, which he believes will produce a better return over the long term.
“But the risk and the volatility associated with that is too big not to have insurance in the portfolio,” Bourdos explained. “The trade off we made is that for the really, really sunny days in the equity market, we’re going to leave a little money on the table in order to pay for that protection.”
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