To Option Or Not To Option With ETFs

March 02, 2009

Adviser offers portfolios with and without options, saying he's trying to educate investors about what such strategies can and can't accomplish. 

 

When Kirk Kinder starts talking to investors about building portfolios, one of the first issues he raises is how risky stocks and bonds can be in volatile financial markets.

Such a tolerance for risk, says the Bel Air, Md.-based portfolio manager and adviser, can't be overemphasized—especially in current times.

"A lot of investors got burned in the Tech wreck of 2000-2002," said Kinder. "Now, with another bear market coming six years later, people are really starting to reconsider their asset allocation plans."

He doesn't consider that necessarily a bad move. "It's not a bad idea to review your asset allocation," said Kinder, who's president of Picket Fences Financial, which also has offices in Clearwater, Fla. "But a lot of people are turning way too conservative. It's a mistake to panic at this point based on what has happened in the past year or two."

The 38-year-old former Coast Guard officer likens creating portfolios to building a ship. "You can build a cruiser or you can build a cutter for speed," said Kinder. "It all depends on where you're trying to go and how fast you want to get there."

When you run into rough weather, he points out, trying to outrun the storm or change course drastically can lead to even worse damage. "Believe it or not, if you're out to sea, you actually want to head right into the storm," said Kinder. "We were always trained that if a hurricane comes, trying to outmaneuver it can make things much worse."

He uses mostly exchange-traded funds for his clients and works with all income levels of investors. He charges 0.50% for a standard portfolio; depending on portfolio size, that can go below 0.25%.

"But for many people with smaller portfolios, that's still going to be cost-prohibitive," said Kinder. "So we'll work with them on an hourly basis and give specific recommendations."

Options Strategies With ETFs

Kinder has broken his strategies into six different model portfolios. "There are several variations from those, depending on individual situations," he said. "But those six serve as our main guide."

Kinder likes to use options with ETFs for investors requiring high levels of current income. "It can help lower portfolio risk and generate additional income on the ETFs," he said. "But a lot of people are scared of options. For those that are comfortable with an options strategy, we've made it a permanent part of their portfolios."

For example, he's using options with the SPDR S&P 500 (NYSE: SPY) for some clients. Kinder notes that the ETF now is currently yielding around 3.5%. "We'll sell an option for one month out. That means we're going to collect premiums from the buyer of the option. But they've got the right to call the option and come back to us and essentially take back our shares of SPY at a predetermined price," said Kinder.

Typically, he usually sells options on SPY and other ETFs about 10% above their current prices. "If the market goes up, our clients will still experience a 10% gain in their holdings. Plus, they get the premium they receive, which on SPY is drawing about 1% in extra income right now," said Kinder.

By remaining short term with his options strategy, he notes, "in a sideways-moving market, you can generate considerable additional income each month."

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