An underutilised tool in income investing – ASX Options
Income investing is back in the headlines as rising rates drive better returns from defensive assets.
For the first time since July 2011, the three-year bond rate of around 4.2 per cent in July was equivalent to the nominal dividend yield on the benchmark S&P/ASX 200 Index.1
But, in a little-known investment fact, there is another source of income many financial advisers and investors overlook – the income generated from the use of Options.
Te Okeroa, Head of Sales, Trading and Customer Relationships at AUSIEX, notes that while option strategies can provide varying levels of upside potential and downside risk mitigation, they can also provide an extra source of income which may be attractive in the current investment climate.
“Options offer sophisticated investors more than the ability to diversify by leveraging different underlying assets,” he says.
“For example, writing covered call options can potentially provide income from the premiums received from writing these contracts.”
This type of strategy consists of buying a stock or ETFs and selling a call option on those same securities. The sale of the option contract provides the writer with a premium, which helps to lower the breakeven point on the underlying investment.
There has been some speculation we are in for a volatile earnings season, with tough trading conditions, recession risk and uncertainty around interest direction having the potential to result in missed earnings targets. In this environment, prudent usage of options may be helpful given as market volatility rises, the premium received upon writing a contract typically increases as well.
While there may be some foregone upside potential, the premium helps the strategy perform in volatile markets – while also generating income.
“This adds to the benefits of options, potentially enhancing their total returns while reducing risks,” he says.
More options for advisers for customer engagement
Te says the potential for using options for income provides financial advisers with another reason to have a conversation with their clients, particularly those with large equities portfolios from which some additional income can boost overall portfolio performance Retirees, SMSF clients or other significant investors with a more defensive posture may also see benefit in such a strategy.
“Income generation from premiums is only one of a large number of strategies and benefits utilizing options including downside protection, providing the opportunity for advisers to have really value-adding conversations with their clients. Options give you options” says Te.
Advisers need to be Accredited with ADA1 to provide advice on covered call strategies. Advisers can be accredited through the Stockbrokers and Investment Advisers Association (SIAA).
As for risks, removing some of the upside potential can reduce gains if the stock rallies well above the option strike price.
Income investors have never had as much choice as they do today. That choice can include options, which may also help protect their equities investments.
AUSIEX can help advisers learn more about the required training. For more information about our options trading solutions, training and other adviser support please contact us.