In the current market environment, volatility is very high and most traders are spending as much time on risk control as on any other activity. This is appropriate but there can be some challenges in that, especially for smaller traders.
For example, one of the most popular options strategies for retail investors are covered calls, but they typically require you to buy at least 100 shares of stock to sell a single call contract.
If you were selling covered calls against the SPDR S&P 500 ETF (SPY) you could be out $9,000 or more for 100 shares. That may be out of reach for smaller traders.
But there are solutions to this problem that preserve the benefits of selling a covered call without requiring a large capital investment.
The same company that lists the popular PowerShares QQQ Trust (QQQQ) also lists the S&P 500 BuyWrite Portfolio ETF (PBP). This ETF replicates the results of selling covered calls each month on the SPY, but is only about $17 per share, and can be purchased as a single share or several thousand shares depending on your capital and needs.
This allows smaller traders to harvest the benefits of a covered call without the minimum capital requirements.
Investing with covered calls has been shown to provide the same growth potential over the long term in a diversified stock index but reduces volatility.
Reducing volatility means that you are risking less for similar returns. This is usually what traders are talking about when they say their strategy is generating “alpha” or excess returns.
In the video below I will walk through an example of how a covered call strategy like PBP compares to simply investing in a stock index.
This article originally appeared on the Learning Markets Web site.