Video: Two Funds that Harness Volatility

In this Morningstar video report, Manager Research Analyst A.J. D’Asaro explains the basics of the option-collar strategy and reviews a pair of option-collar mutual funds: The Gateway Fund (GATEX) and the Schooner Fund (SCNAX). Both funds use option-collar strategies to provide stock-market exposure with less volatility. The strategy involves holding stock long, selling call options on the stock to receive income, and buying put options to protect against losses. Option-collar strategies give away some upside in exchange for income and predictability, and use some of that income to buy puts to protect against downside – in this way, they greatly dampen volatility.

A.J. D’Asaro says Morningstar recommends both the Gateway Fund and the Schooner Fund, but the Gateway Fund is the superior of the two. The objective of option-collar strategies is to dampen portfolio volatility, and the Gateway Fund’s beta of 0.35 – compared to the Schooner Fund’s 0.5 – shows that is has done a better job of doing so. The Schooner Fund’s nominal returns have been greater than Gateway’s, but on a risk-adjusted basis, the two funds are roughly equivalent; and in D’Asaro’s opinion, Schooner’s more tactical use of collars requires greater management skill and is thus riskier.

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