Josh Charlson: Today, we'll be talking about two long-short equity funds that employ covered-call strategies, also sometimes referred to as option-collar strategies.
The two funds are Silver-rated Gateway (GATEX), which has been around since 1977, and Swan Defined Risk (SDRAX), a Bronze-rated fund that's a more recent entrant to the fund world but which has existed in a separate account format since 1997.
Both funds are fairly similar in their outlines. Both invest in a core equity portfolio that's modeled on the S&P 500; they write calls on the portfolio to generate premium income, which caps the upside; and then they purchase protection, usually through puts, which sets a hedge on the downside. Thus, you have your collar.
But beyond those structural similarities, there can be key differences in how managers invest the equity portfolio and how they structure the option components of the strategies, which can lead to significant performance differences.
Differences between Gateway and Swan Defined Risk are evident when we look at their performance during the August 2015 market correction. During a six-day period when the S&P 500 was down 9.4%, Swan was down 7.8% while Gateway was down only 4.6%--less than half the index.
Two major factors account for that difference. Gateway sets its puts at an average of 8% out of the money, with 40- to 60-day expirations, while Swan uses longer-term puts set at 10% out of the money. That means that Gateway's puts will kick in during a less-severe market correction, while Swan's are designed to protect during more of a bear-market environment; thus, they did not really help in August.
Moreover, Swan Defined Risk not only writes call options but put options as well, providing an additional source of income. However, those options experienced short-term unrealized losses during the August volatility.
There's no right or wrong approach to a collar strategy, but staying aware of the nuances of a fund will help make sure your expectations are properly set. Covered-call strategies have a long history of effectiveness as a way to get exposure to equity markets with reduced risk.