Getting paid for volatility
IN Partnership with
A leader in equity income, Harvest ETFs CIO Paul MacDonald explains why its proven covered-call options strategies are ideal for challenging market environments
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MARKETS WILL remain volatile in the near-to-medium term, economists say. This might sound alarming to investors, but it shouldn’t. The notion that volatility means depressed markets is a myth. In fact, it can provide the environment for returns that exceed expectations, something skilfully exploited by Harvest ETFs’ covered-call strategies.
Harvest is a leader in the equity income field, driven by a proven ability to invest in quality areas of the market where it expects long-term growth. These areas are often
Harvest ETFs is an independent Canadian Investment Fund Manager managing $3.2 billion in assets. At Harvest ETFs, we believe that investors can build and secure wealth by owning high-quality businesses for the long term. Since 2009 we have built investment products to deliver on that philosophy
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Monthly Option process
Assessment of required write level given current market conditions
“We know our companies well and deeply, and this allows us to be more engaged as we employ our options strategies”
PAUL MCDONALD,
HARVEST ETFs
sector-focused, like health care (Harvest Healthcare Leaders Income ETF) or technology (Harvest Tech Achievers Growth & Income ETF), and feature large- and mega-cap companies.
The firm writes covered-call options – an agreement that gives someone the right to buy a stock at a specific price (strike price) for a specific period – on its Equity Income ETF, generating income for investors who also benefit from the growth of the companies Harvest ETFs invest in.
The trade-off, of course, is that while you get sizeable cash flow with a degree of certainty each month, you forgo some of the possible upside. Harvest’s Equity Income ETFs, however, participate on the upside in at least two-thirds of their positions. Because Harvest ETFs’ call-option strategy is actively managed, portfolio managers can expose even more of the portfolio to potential upside, especially when market volatility is higher. It’s a winning proposition, as Paul MacDonald, chief investment officer and portfolio manager at Harvest ETFs, noted.
“The benefit to unit holders is that they get exposure to large- and mega-cap-focused funds, but they will also get the benefit of the high cash flows paid monthly.”
Options are priced on implied volatility, so the higher the volatility, the more potential for greater cash flow. MacDonald revels in this type of environment and stressed that Harvest’s options strategies are underpinned by a rigorous, structured stock-picking approach. Each ETF, for example, holds only around 20 names at any one time. It follows a structured process to determine which stocks are included in each portfolio, a process Harvest ETFs calls its DNA. It defines a universe – for example, a specific sector of the market or a particular segment of large-cap stocks; it then narrows that down, using quantitative financial factors, such as minimum market capitalizations; finally, it actively selects 20 names based on fundamental analysis and specific diversification and valuation metrics.
MacDonald said, “More analytical power goes into the selection of the companies on the active equity income mandates. On the options strategy, having relatively concentrated portfolios allows us to be more engaged with the individual companies in the diversified strategies; we know our companies well and deeply, and this allows us to be more engaged as we employ our options strategies.”
Identifying these stocks then feeds into Harvest ETFs’ successful income strategy and active covered-call process. At the start of each month, portfolio managers determine how many options must be written on each fund to generate the required cashflow. This sets the tone for more detailed analysis of market dynamics, options valuations, volatility metrics, and any specific anomalies. This process helps determine why volatility is expected to be higher or lower during the month, and gives them the data to decide how much to write on different securities and at what strike price.
income that is driven by a proven strategy and skilled people who know the markets deeply.
“We are always invested in the underlying stocks. We're really delivering on option execution, and on those strategies across each one of our equity income mandates,” MacDonald said.
He added, “Where we are allocated to the areas of focus in the market is step one. By proving [ourselves] across very challenging environments, it really does bring us to the forefront. This is when you want to have an experienced hand in these types of strategies.”
“We are always invested in the underlying stocks. We're really delivering on option execution, and on those strategies across each one of our equity income mandates”
PAUL MCDONALD,
HARVEST ETFs
He explained, “One area we continue to like is health care. [Investors could ask,] is this an area that I want to be invested in? We have an active selection process on the [ETF] side, and that is very much a valid component of our strategies. The covered-call strategy is very useful for those looking for monthly cash flows, but in the current environment, they can add to total returns when returns are hard to come by.”
Covered-call options can provide many of the advantages advisers seek, including monthly income that can be added to total returns. Harvest ETFs’ active approach improves on this by selecting large capitalization stocks in areas that have long-term growth potential and by providing regular equity
Share
Share
Harvest ETFs’ DNA
Net income requirements
01
Review of market metrics and market volatility analysis
Broad sub sector analysis
02
Assessment of option metrics in the overall portfolio
Portfolio level analysis
03
Catalyst calendar;
S-T technicals; multiple option chain analysis
Stock level analysis
04
Buy-back
opportunities
Daily monitoring
05
Monthly review of option strategy
Post expiry analytics
06
HOW HARVEST ETFs STRIKES A CALL OPTIONS BALANCE
Premiums offset potential loss in value
No call options
100% written
Strike Price $100
Call Options trade some upside potential for premiums
-$6.00
-$4.00
-$3.00
-$2.00
-$1.00
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
$7.00
$8.00
$96.00
$97
$98
$99
$100
$101
$102
$103
$104
$105
$106
$107
$108
Harvest ETFs' active management balances appreciation & income
A
B
Covered Call Options Payoff = Premiums + Market Growth
Three strikes and you’re in
Unlike passive covered-call offerings, Harvest ETFs can use multiple strike prices to take full advantage of market volatility. For example, while usually writing one percent “out of the money” – $101 on a $100 stock – a security could also be written further out of the money, for example 10 percent out of the money at $110 during periods of high volatility. In addition, if they anticipate a stock appreciating in the short term, it can be flexible; the portfolio manager might write 10 percent of the security at $101, 10 percent at $105, and 10 percent at $110 as the stock appreciates through the month, should that occur, rather than systematically writing one level each month.
But before committing to a covered-call strategy, MacDonald believes investors should first ask themselves whether they want to be invested in that area. If they do, then exposure with a covered-call strategy is a way to do more than just “withstand the volatility; you can get paid for that volatility.”
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Harvest ETFs is an independent Canadian Investment Fund Manager managing $3.2 billion in assets. At Harvest ETFs, we believe that investors can build and secure wealth by owning high-quality businesses for the long term. Since 2009 we have built investment products to deliver on that philosophy
“We know our companies well and deeply, and this allows us to be more engaged as we employ our options strategies”
PAUL MCDONALD,
HARVEST ETFs
Options are priced on implied volatility, so the higher the volatility, the more potential for greater cash flow. MacDonald revels in this type of environment and stressed that Harvest’s options strategies are underpinned by a rigorous, structured stock-picking approach. Each ETF, for example, holds only around 20 names at any one time. It follows a structured process to determine which stocks are included in each portfolio, a process Harvest ETFs calls its DNA. It defines a universe – for example, a specific sector of the market or a particular segment of large-cap stocks; it then narrows that down, using quantitative financial factors, such as minimum market capitalizations; finally, it actively selects 20 names based on fundamental analysis and specific diversification and valuation metrics.
MacDonald said, “More analytical power goes into the selection of the companies on the active equity income mandates. On the options strategy, having relatively concentrated portfolios allows us to be more engaged with the individual companies in the diversified strategies; we know our companies well and deeply, and this allows us to be more engaged as we employ our options strategies.”
Identifying these stocks then feeds into Harvest ETFs’ successful income strategy and active covered-call process. At the start of each month, portfolio managers determine how many options must be written on each fund to generate the required cashflow. This sets the tone for more detailed analysis of market dynamics, options valuations, volatility metrics, and any specific anomalies. This process helps determine why volatility is expected to be higher or lower during the month, and gives them the data to decide how much to write on different securities and at what strike price.
Companies
About us
Privacy Policy
Terms of Use
RSS
People
Newsletter
Authors
External contributors
Copyright © 1996-2023 KM Business Information Canada Ltd.
Contact us
News
Your Practice
Investments
Resources
Best in Wealth
Subscribe
News
Your Practice
Investments
Resources
Best in Wealth
Subscribe
Companies
About us
Privacy
Terms of Use
RSS
People
Newsletter
Authors
Contact us
External contributors
Copyright © 1996-2023 KM Business Information Canada Ltd.
Stock Profit/Loss
Full Covered-Call P&L
A
B
Even if stock goes lower, investor still keeps the premium
Current Share Price - $100 &
Strike Price - $100
Writing a call option on 100% of a holding gives you very high income but you do not participated if stock moves higher
Maximum profit -
Premium From Call Option
Share Price
-$5.00
-$4.00
-$3.00
-$2.00
-$1.00
$0.00
$1.00
$2.00
$3.00
$4.00
$5.00
$6.00
$7.00
$8.00
$96
$97
$98
$99
$100
$101
$102
$103
$104
$105
$106
$107
$108
covered call strategy pay off
-$4.00
-$2.00
$-
$2.00
$4.00
$6.00
$8.00
$10.00
Share Price
$97.00
$98.00
$99.00
$100.00
$101.00
$102.00
$103.00
$104.00
$105.00
$106.00
$107.00
$108.00
33% written
Profit
No call options
100% written
Premiums offset potential loss in value
Strike Price $100
Covered Call Options Payoff = Premiums + Market Growth
Harvest ETFs' active management balances appreciation & income
Call Options trade some upside potential for premiums
-$6.00
$96.00
HOW HARVEST ETFs STRIKES A CALL OPTIONS BALANCE