How one advisor explains covered calls to clients

Each month at WP we offer a slate of articles and content pieces that go deep on a particular topic. This October, we're focusing on volatility offsets in ETFs.

Peter Kollias uses covered call ETFs in some allocation for almost every single client in his practice. The Senior Wealth Advisor and Portfolio Manager at Cresco Wealth Management of Wellington-Altus Private Wealth builds his client portfolios with allocations to equities, fixed income, cash, and alternatives. He puts covered call ETFs into that alternative sleeve because they turn market volatility into an asset class, where higher periods of volatility can be monetized through options premiums and provide cash flow for clients.

“They fulfill our need to manage risk, to manage volatility, and to optimize income for our clients within an asset allocation strategy,” Kollias says.

Clearly a proponent of these strategies, Kollias strives to ensure his clients fully understand what can be a relatively technical product that comes with inherent trade-offs. He outlined how he approaches client conversations about these ETFs, why he recommends them to clients, how he fields common questions, and how he arrives at a place where clients are fully buying in to what they’re getting. It’s a conversation that begins with the underlying investments rather than the specific options mechanisms.

“What endures in the long term is having the right strategies that invest in really good companies, companies that have good cash flow, companies have good management, companies that do a good job of reinvesting their cash flow for the long-term that are going to endure in moments of difficulty,” Kollias says. “From there we look at volatility as an asset class that we want to monetize.”

While Kollias and his team try to keep the high-level strategic goals of their clients’ asset allocation in mind, they can also go granular on covered calls. Kollias believes that informed clients will make the best decisions and he and his team will show those clients why they prefer certain covered call strategies over others. They’ll explain how a systematic write strategy can end up capping more upside than clients would want in any situation. They’ll explain the trade-offs inherent in all covered call strategies, where some upside is given up in favour of income. They’ll show how their preferred active covered call strategies are able to better minimize those upside trade-offs and take advantage of volatility’s relationship to options premiums.

While not all clients will walk into his office understanding the nature of options pricing, Kollias notes that there is a growing sense of concern and unease about the sheer amount of volatility on the market today. He can frame those concerns as a positive and talk about the exact nature of volatility and how it impacts markets. Starting from the place of client worry, he can take them to a place where they grasp why this strategy might make sense for them.

Just as he doesn’t ignore the technical details, Kollias doesn’t ignore the downsides. He acknowledges the fact that options ETFs cap some upside. However, he is specific with how much upside is capped and puts that trade off in the context of the overall returns profile, which includes cash flow taxed as capital gains. The mixture of tax efficiency, cash flow, and volatility relationships, he says, are normally enough to gain client buy-in.

Any advisor will tell you, though, that one conversation might not always be enough to ensure the client is fully educated on a strategy. Kollias uses the old mantra that repetition is the mother of study in his approach, he will reiterate the reason why his clients are using these strategies at every opportunity. In periods when they may question the utility of the strategy down the road, he can use those repeated earlier conversations as a touchstone to reset client expectations and remind them of their goal with these ETFs.

Kollias is also clear with his clients about how he’s arrived at the specific products he’s recommending. The covered call ETF market is only getting more crowded in Canada, and showing why he chose one product over another is both a regulatory and a moral responsibility for Kollias. He and his team will assess providers based on management expertise, fundamental investment approach, and options strategies. They will ask about the timing of call writes, management of overseas options markets, and tax efficiency. They will look for NAV ‘grinds’ to weed out poor products and showcase all of their diligence to clients. As other advisors explore these products and consider recommending them to their clients, Kollias believes they need to begin with that robust due diligence.

“I wouldn't make a recommendation until you fully understand the strategy and the product,” Kollias says. “The other piece is to ensure that the strategy fits your overall portfolio as it relates to the plan for your clients. Don't put it in there just because the yield looks good.”