The Portable Yield Strategy (PYS) seeks to provide a steady level of incremental income (option premium) through the systematic writing of index-based call and put spreads.
- The strategy requires no initial funding by the client. The client posts collateral/margin to cover maximum loss potential required by the broker, and cash to settle any losing trades.
- The use of spreads has an objective of a pre-defined maximum risk budget on outstanding positions.
- The return stream is independent of the beta source.
In seeking an incremental annual return, Rampart writes short-dated (typically two-week), out-of-the-money (OTM) put and call spreads on the S&P 500® Index (or some other equity index).
Writing a call spread involves the sale of a call option (a short position) and the simultaneous purchase (a long position) of a call option with the same expiration but with a higher strike price (i.e., farther out-of-the-money). Similarly, writing a put spread involves the sale of a put option and the simultaneous purchase of a put option with the same expiration but with a lower strike price. Rampart uses a disciplined and rules-based mathematical process to execute the trades.
If the index at expiration is between the short call and the short put strikes, all premium generated is kept. Only one side of the spread (put or call) can result in a loss at expiration. The maximum loss is equal to the spread on the call (or put) strike prices minus the premium received.
Rampart adjusts the strategy based on implied volatility (estimated changes in value of the index over a short period of time). As implied volatility increases, spreads are written farther out-of-the-money so that there is less risk that the option will be exercised and the incremental income decreased.
- PYS can serve as an overlay on any marginable asset; current holdings or allocations do not need to change.
- With the potential to earn additional income on current assets, these assets essentially can become more productive.
- PYS seeks to provide an alternative to increasing the risk profile of one’s asset allocation (more equities or lower-quality bonds) in order to attain cash flow.
Important Risk Considerations
If the S&P 500® Index becomes more volatile, causing more of the short calls and puts to settle in-the-money, there will be a negative impact on performance.
If liquidity and pricing transparency in the weekly expirations diminish on out-of-the-money strikes, there may be a negative impact on performance.
Transaction costs may be significant in multi-leg options strategies, including spreads, as they involve multiple commission charges.
If the underlying portfolio is either highly positively correlated or highly negatively correlated with the S&P 500® Index, there may be times when the losses experienced in the underlying portfolio are exacerbated by the PYS overlay.
If the S&P 500 listed options become unavailable to trade, Rampart may be unable to implement the strategy.
Margin requirements for option writers are complicated and not the same for each type of underlying security. They are subject to change and can vary from brokerage firm to brokerage firm. As they have significant impact to the risk/reward profiles of each trade, writers of options (whether they be calls or puts alone or as part of multiple position strategies such as spreads, straddles, or strangles) should determine the applicable margin requirements from their brokerage firms and be sure that they are able to meet those requirements in case the market turns against them.
There is no assurance that Rampart Investment Management will be successful in implementing the Portable Yield Strategy (e.g., identifying or exploiting option pricing inefficiencies).