Finding Upside on the Downside

At Luminist Capital, we use option overlays to provide protection against investment losses. An option overlay is a combination of call and put options layered on top of a core investment. We apply option overlays to ETFs in several of our models.

On 12/29/17 I put some new money to work in one of our Alternative Yield models. I bought shares of XLU @ $52.59 and layered in our yield enhancing option overlay on the stock. Fast forward to 3/16/18 and XLU is now $50.25, 4.4% lower, as rising interest rates have taken their toll on utilities. This model is down just 0.32% over the same period. There are several reasons for this outperformance, first among them is the downside protection the option overlay provides. We buy puts to cap the downside and sell other options to cover the cost of the protection. One of the very tangible benefits of this strategy only reveals itself in down markets. Here’s an example of how it works:

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