Unique options to protect the downside in portfolios

During times of crisis such as the current war in Ukraine and rising global tensions, markets tend to fall because of fear and uncertainty. Advisers looking for a way to hedge against this declining market or the possibility of a decline to come might want to consider using covered call options for their clients, especially when trading in rangebound markets. Such instruments can enhance returns via the premium collected from a covered call strategy.

Instead of writing covered calls, advisers can buy the Global X Nasdaq 100 Covered Call ETF (NASDAQ: QYLD) exchange-traded fund. It does it all for you. The ETF is designed to offer clients monthly income while seeking to lower the risks of investing in a major US index through a strategy that writes monthly covered call options on the Nasdaq 100 Index.

This is how it works:

QYLD’s Covered Call-Writing Process:

1. QYLD buys all the equities in the Nasdaq 100 Index
2. QYLD then sells Nasdaq 100 Index options (NDX) to a counterparty that will expire in one month
3. A premium is received in exchange for the sale of the index options
4. At the end of the month, QYLD seeks to distribute a portion of the income from writing/selling the NDX index option to the ETF shareholders.
5. At the beginning of each new month this process is repeated

The ETF gives up the profit potential if the index rises above the strike price of the index call option.

So, for example – If the Nasdaq 100 Index finished the month below the strike price, the call option would expire worthless, and premium would be received. This could be used to offset the decline in the underlying equities.

In an upmarket, the index price continues to rise but the potential gain will be limited since the fund sold a call option at a strike price below the index price. As the index price rises above the strike price, the premium is retained but the upside potential from the index price is capped.

QYLD performed better than the Nasdaq 100 index during certain downtrends.

Ishan Dan

Ishan is an experienced journalist covering The Inside Investor and The Insider Adviser publications.