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Portfolio > Portfolio Construction

Options for Growth

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Diversification isn’t just for client portfolios. New research shows wealth managers are embracing options to enhance and supplement their clients’ portfolios, as nearly half of all advisors have used options for at least one of their clients in the past year. The Options Industry Council-sponsored Bellomy quantitative benchmark study on advisors’ use of options demonstrates more widespread use by wealth managers across all channels. Financial advisors who use options tend to have larger books of business and are more experienced than those who do not use options.

Options Volume Continues to Grow
Options volume for the month of July was over 348 million contracts, which is a 26% increase over July of last year; year-to-date volume through July 2011 stood at 2.6 billion contracts, up 13% over the same period last year. Additionally, options trading volume has set a new annual record for the last eight consecutive years and is currently on pace for another record year.

Option use among advisors is a response both to current market conditions and to a shift in client attitudes. Clients are asking for ways to avoid the losses of the past few years and to enhance their returns in the current market. Jennifer Hartmann, CIMA senior portfolio manager at Morgan Stanley Smith Barney-The Pelican Bay Group, views portfolio allocation in a third dimension. “We need to not only monitor and be tactical for both the long and short dimension of the client’s portfolio in this current low-interest rate environment, but also seek to provide protection of any downside risk—options are uniquely suited to respond to both.”

Technology is Key
Many advisors express concern over the time commitment and intricacy associated with implementing an options strategy for one client, let alone several. Hartmann acknowledges the concerns of financial advisors that options require additional time and monitoring, but asks, “How else do you expect to stay ahead of the competitors on the street?” Additionally, she points out that, “Technology has been the key that enables our team to manage 930 option accounts across multiple stocks.” The Pelican Group has been managing three distinct covered call strategies through Portfolio Management, an advisory program in which the client’s financial advisor invests the client’s assets on a discretionary basis in a wide range of securities, the most popular among its clients (and the most common options strategy used among financial advisors) for 10 years now.

According to Jon Najarian, co-founder of optionMONSTER (which provides stock market insight, option trade ideas and options education) and CNBC commentator, “More and more RIAs are contacting us to learn about income-oriented options strategies and are looking for services that are specifically designed to assist RIAs and FAs in locating opportunities that bring in extra income for their client’s stock holdings.” Hence, he says “there are a number of individuals in the advisor community who subscribe to our services that assist with this, such as our Covered Call Investor and InsideOptions Pro.”

Further developments in technology include the rollout by Interactive Brokers (IB) of a new product offering for their SMA accounts, which underscore the growth in options interest from the wealth management community. Steve Sanders, senior vice president of business development and marketing for IB, explains that the platform will ultimately have a “community portal” that allows wealth managers easier access to risk manager relationships via a single separately managed account structure where they can review the performance metrics and fees of options managers they do not currently employ. In real time and through a single login, a wealth manager can immediately allocate funds to each manger. He adds, “While IB has historically designed product offerings on a ‘build it and they will come’ approach, this innovation has been completely built by the requests of the advisory community.”

Another way to incorporate options strategies into client portfolios is to outsource to a group that provides options-based investing solutions. Stephen Solaka, co-founder and managing partner of Belmont Capital, which manages hedged ETF portfolios (Dynamic Collar ETF) and offers single stock risk management solutions for independent wealth managers through Schwab and Fidelity separate account platforms, added that there is trepidation from financial advisors in placing the orders as they don’t want to make a mistake. “That’s why they use Belmont Capital (and similar firms or funds) as the intermediary to implement options strategies,” he said.

Getting Started
More than a third of financial advisors who use options increased their use of options over the past few years and one in three say they intend to increase it going forward, the Bellomy study found. Also, nearly all options users who feel confident in their ability to explain options would be interested in learning more. Solaka thinks more financial advisors will be using options in the next three to five years because “they allow the advisor to directly manage risk,” and the growth in options with financial advisors would be coming from the independent side. Finally, Hartmann of The Pelican Bay Group believes that the fixed income asset class is currently unable to meet the income targets of its clients and says, “Financial advisors need to start getting comfortable with the process and the solutions.”


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