With a US president appearing set to roil markets with executive orders and social media posts, could this strategy help smooth things out for clients?
It looks like we’ll be living with the threat of tariffs for a while. While the looming tariffs on US trade with Canada and Mexico were averted at the 11th hour last Monday, the sound and fury leading up to that deal added a significant dose of volatility to equity markets. Without a firm deal and a 30-day clock on these trade issues, we can likely expect some degree of volatility to continue. President Trump’s latest announcement of universal tariffs on steel and aluminium imports add fuel to the volatility fire. We appear to have a US President who is willing to take actions that could roil markets in the short-term.
So how can advisors manage this ‘presidential volatility’ for their clients? Paul MacDonald believes that covered call options strategies can play a role. The Chief Investment Officer and Portfolio Manager at Harvest ETFs outlined how the role of volatility in option pricing can offer an advantage in unpredictable times. He explained, too, how a more targeted and active approach to option writing can work in the specific circumstances of volatility driven by the actions of one powerful individual rather than a more structural force.
“I think most people, including perhaps Trump himself, are trying to understand the long-term goal here. Whether it’s to change the narrative on global trade or if he is just shooting from the hip to see what he hits,” MacDonald says. “I think there is a lot more emotion involved in what transpired over the past weekend than perhaps we’ve seen during times with more fundamental structural issues… and that volatility, I believe, will stay here.”
MacDonald cites a number of metrics informing his view that volatility will stay elevated and looks notably at Donald Trump’s first administration. He notes that during this period trade policy uncertainty stayed high — with some ebbs and flows — through the entire four-year period. Because of the single source of this volatility, he also argues that we might see individual stocks, subsectors, and sectors being hit with periods of extreme volatility while other parts of the market stay calmer. The very fact that tariffs have been delayed, rather than cancelled, speaks to the kind of volatility overhang we might see.
This is where covered calls come in. Put simply, options premiums are higher when volatility is higher. Covered call options are sold on equity holdings, generating a premium on a certain per centage of an equity holding while capping the upside on that per centage. That is also true of expected volatility, not just real volatility. For a covered call manager like MacDonald and Harvest, they can use the heightened volatility to generate the cashflow they require with fewer options written on their holdings, leaving a higher per centage of their equity portfolio uncapped and exposed to potential upside.
MacDonald and his team are also active in their options writing, which he believes gives them an advantage in this current environment. They can be targeted in their options writing capturing the higher premiums that might emerge on a single sector or even one stock due to decisions made in the White House.
“The nature of ‘presidential volatility’ and that shooting from the hip is that it can occur at different moments, so it won’t hit each company at the same time,” MacDonald says. “So I would say that we’re going to get very spiky sector and stock volatility on that policy risk, compared to past periods where it’s been a bit more systematic due to structural factors like interest rates.”
With a view to this ‘presidential volatility’ MacDonald believes that advisors need to remember to stay diversified first and foremost. When assessing a covered call strategy, MacDonald argues that advisors should first assess the companies in a particular fund and their clients’ need for monthly cash flow. In this moment, however, he argues that the premiums that can be captured with an options strategy can allow advisors to soften some of the spikes we may see in the market, or even keep clients invested in sectors with short-term headwinds. He believes that advisors considering these strategies can explain them clearly to clients as a trade-off with slightly more attractive terms in a volatile environment.
“We want to stay invested and we can by giving up a little bit on the upside in exchange for monthly cash flow,” MacDonald says. “I think advisors can talk about them on a total return basis…And then there might be some opportunities for a more active discretionary portfolio manager to use these strategies to capture alpha over the next 12 months if they think volatility-driven premiums are going to make up a larger portion of their total returns.”
