Managing a Hedged Equity Strategy in Low Volatility Environments

Volatility plays an important role in how we manage some of our hedged strategies and generate returns. This has led to the question “How do we manage volatility-aided strategies in periods of low volatility?”

Because our convertible arbitrage strategy relies on individual stock volatility rather than index volatility to provide gamma trading opportunities and price dislocations, a reduction in market volatility can have less of an impact than it has on our hedged equity strategy, which relies more on index volatility.

In general, we think of our covered call (collared) strategy as short volatility. We generally take in more premium from the calls we sell than we spend on our put protection, and the strategy performs best in a slowgrinding upward market that often coincides with low volatility periods. Therefore, the strategy has tended to work well during the transition phase from a normal volatility environment to a low volatility environment. (Our calls decrease in value while our equities might slowly rise.)

However, if low volatility persists once we get past the transition phase, we often adjust our focus. One of the guiding principles of our market neutral income and hedged equity income strategies is to take advantage of the opportunities the market presents, not the ones we hoped it would present. In normal markets, we are able to generate income from our option hedge as the money we take in selling calls can exceed the money we spend on puts. This becomes challenging or impossible with index volatility at historic lows like we saw in 2017. That said, any time we find ourselves talking about “historic” levels, there are often opportunities as well.

For strategies like ours that rely on providing downside protection, the opportunity presented in low volatility environments is clear. Just as the price of the calls we sell is lower, the price of the puts we need to buy is lower too. This allows us to add more hedge through puts than we would normally be able to purchase. Similar to a shopper at a store, with the price of downside protection low, we can afford to stock up. We need to manage the cost of that in conjunction with the decreased income we discussed earlier, but the lower cost can allow us to be more hedged should a period of complacency end with a downside move.

If the low volatility persists, we will continue to focus on capturing individual equity volatility in our convertible arbitrage strategy, while aggressively monitoring our option income/spend. Also, as always, we are working to identify and take advantage of opportunities the market presents. Although it may limit our income, a reduced call overwrite combined with increased put protection can leave us positioned favorably whether the low volatility environment is just a pause before the next leg of a continued bull market or simply the calm before the equity storm.

For more information, see:

Return to the Volatility Guide


Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.

Past performance is no guarantee of future results.

The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Information contained herein is for informational purposes only and should not be considered investment advice.

Important Risk Information. An investment in the Fund(s) is subject to risks, and you could lose money on your investment in the Fund(s).There can be no assurance that the Fund(s) will achieve its investment objective. Investment in the Fund(s) is not a deposit in a bank and is not insured or guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency. The risks associated with an investment in the Fund(s) can increase during times of significant market volatility. More detailed information regarding these risks can be found in the Fund’s prospectus.

Some of the risks associated with investing in alternatives may include hedging risk, derivative risk, short sale risk, interest rate risk, credit risk, liquidity risk, non-U.S. government obligation risk and portfolio selection risk. Alternative investments may not be suitable for all investors.

The principal risks of investing in the Fund(s) include:

Market Neutral Income Fund: convertible securities risk, synthetic convertible instruments risk, convertible hedging risk, covered call writing risk, options risk, short sale risk, interest rate risk, credit risk, high yield risk, liquidity risk and portfolio selection risk.

Hedged Equity Income Fund: covered call writing, options, equity securities, correlation, mid-sized company, short sale, interest rate, credit, liquidity, portfolio selection, portfolio turnover, foreign securi-ties, American depository receipts, and REITS.

As a result of political or economic instability in foreign countries, there can be special risks associated with investing in foreign securities, including fluctuations in currency exchange rates, increased price volatility and difficulty obtaining information. In addition, emerging markets may present additional risk due to potential for greater economic and political instability in less developed countries.

Before investing carefully consider the fund’s investment objectives, risks, charges and expenses. Please see the prospectus and summary prospectus containing this and other information which can be obtained by calling 1-800-582-6959. Read it carefully before investing.


David O’Donohue

David O’Donohue
Senior Vice President, Co-Portfolio Manager