Beyond Long-Only Equities: Options Strategies to Align with Portfolio Goals

As the COVID-19 pandemic took hold in March 2020, the stock market experienced some of its toughest days, days when most investors were pained to look at their portfolios. After sinking more than -10% in the second half of February, the S&P 500 Index fell another -7% in the early days of March. This was followed by a -9.5% drop on Thursday, March 12th, the worst one-day decline since the 1987 Black Monday crash. The Trump administration's declaration of a national emergency on Friday, March 13th, along with the implementation of shutdown orders by many states over the following weekend, led the market to end Monday, March 16th down another -12%.

More recently we saw extreme volatility in late July/early August with growth concerns triggering a selloff in the US markets and the VIX briefly spiking to levels last seen in March 2020.

Amid such extreme market volatility events, many investors wondered how they could experience the stock market's upside without the drawdowns.

Is there a way to have our cake and eat it too?

In a sense, there is. Options allow investors to target precisely the risks they want to take in order to better achieve portfolio objectives. The innovation and proliferation of financial derivatives have made options-based strategies more accessible to asset owners. A recent PGIM Quantitative Solutions white paper described three strategies available to help investors improve portfolio outcomes:

• Defined Outcome strategies are derivative-based investments that alter a long-only investment payoff, providing fixed-term, guaranteed downside protection with a variable upside cap. This "Cap-Buffer" structure, also colloquially known as a "Buffered" strategy, provides exposure to an index combined with downside protection by buying/selling call/put options.
  
• Covered call strategies can provide comparable or superior returns to an investment in equities alone, but with less volatility, lower drawdowns, and significant income enhancement. In recent years, particularly in the ETF space, covered call strategies have been highlighted for their ability to generate consistent income through the sale of call options.
  
• Asymmetric convexity strategies with long horizon call options provide upside equity market participation and downside protection at a range of risk and exposure levels across a variety of equity indices. These "defensive equity" strategies aim to reduce the impact of market volatility by limiting both gains and losses.
  

Options-based strategies have long offered institutional and high net worth investors the ability to construct portfolios with more targeted outcomes than possible with traditional long-only equity exposure. The proliferation of options-based retail offerings in recent years, primarily in ETFs, has made these strategies accessible to a much broader investor base. Whether the goal is consistent high income, downside protection, or better risk adjusted returns, flexible options-based strategies can be tailored to create customized solutions at any desired strike or expiration. By helping investors fine-tune their portfolios, options-based strategies can better align their portfolio with their goals.