Charlie Spiring, Chair–man of Winnipeg-based investment dealer Wellington West Capital Inc., doesn’t like to sit idle while waiting for the markets to come out of a funk. When the mood is bearish, he seeks an antidote for his clients in simple options strategies.

“We use options strategies to mitigate risk in down markets,” Spiring says. “I’m all about risk management, and there are some strategies that can help clients get out of the soup. From the advisors’ point of view, if they can offer a strategy to deal with negative markets, they can help clients ride out the storms, sleep better at night and preserve the value of their clients’ portfolios.”

A key strategy currently being used at Wellington West is the sale of long-dated call options on individual stocks currently owned by the client.

A call option gives the purchaser of the option the right to buy the stock at a specified price on a specified future date, while the client who sells the option receives a fee for selling that privilege, whether it is ultimately exercised or not. In the latter case, the client also locks in a selling price for the stock, no matter what the stock price does.

For example, a client could own 1,000 shares of CIBC, which were recently trading at $49 each. The client could then sell 10 long-term equity anticipation calls, or LEAPs, on 100 shares each, with an expiry date of January 2010 and an exercise price of $54 a share. The client would receive $4.25 a share for the LEAPs, or $4,250 in total. If CIBC stock doesn’t change before the options expire, the call options would expire unused and the client would make $4.25 a share, or 9.5%.

If the stock price increases to more than $54 a share, the call option will be exercised at $54, and the client will make an additional $5 a share on the sale of the stock, bringing the total return to $9.25 a share, or almost 20%, which Spiring considers a pleasing return in today’s unpredictable markets.

Even if the stock falls, the client’s break-even point has been lowered to $44.75 a share ($49 minus $4.25), creating a valuable cushion.

“Selling a covered call is a low-risk strategy,” says Spiring, “and can be used to do a ‘fix and repair’ on a stock that’s already down.” Spiring has been through seven bear markets since he launched Wellington West in 1981.

The downside of this strategy is that the client’s selling price is capped, and if the stock rises higher than the option price, the client will miss out on the rest of the profit.

“The risk is lower using the option strategy than just owning the stock itself,” Spiring says. “Effectively, you’ve paid less for the stock. I’d like the market to double over the next while. But it’s not hard to believe we have a tough year ahead. Clients ought to know that there are other investment strategies besides ‘buy and hold’.”

Spiring says Wellington West has made options strategies a point of differentiation in the highly competitive securities industry. About three-quarters of the firm’s advi-sors are licensed to trade options. At Wellington West, Spiring says, there has been a lot of advisor education lately in how to use options to neutralize a portfolio or to capitalize on a bear market.

“The more arrows in your quiver in this kind of a market,” he adds, “the better.”

Although the LEAPs call strategy focuses on specific stock options, many clients have made some healthy profits during the recent market dive by shorting indices that represent entire markets or market sectors such as financial services or gold.

Indices or stock sectors can be shorted by short-selling exchange-traded funds such as those offered by Barclays Global Investors Canada Ltd. and Claymore Investments Inc., or by using bear-market funds offered by BetaPro Management Inc., all of Toronto. The Horizons BetaPro family of Bear Plus ETFs offer 200% of the inverse daily return of various commodities or sectors and cover a variety of markets, including global mining companies, gold bullion, agricultural commodities and stock market indices.


The advantage of the BetaPro ETFs is that even the bear ETFs are considered to be long securities and, therefore, are eligible for RRSPs. Losses are limited to the initial invested amount — unlike regular short-selling, in which a rising stock or index can trigger margin calls and create unlimited losses for the client who is short on that security.

@page_break@“At one point, we were 45% short on our client portfolios, and the BetaPro funds were giving us double the exposure on the way down,” says Ross Healy, chairman of Toronto-based money manager Strategic Analysis Corp. “It was very sweet. You can use them to put on as much or as little a hedge as you wish.”

Robert Robinson, executive chairman of private investment-management company R.H.R. Capital Corp. International in Toronto, has been using BetaPro NYMEX Crude Oil Bear Plus ETFs to profit from falling energy prices.

Using ETFs is a safer strategy than going short on specific stocks, he says: “I prefer to hedge against the overall oil price rather than target a specific company and short the stock. A company could make a major discovery, and even if you were right about the oil price falling, you could be offside in your short position on that particular stock.”

Other portfolio managers have profited from regular short-selling strategies. Jean-François Tardif, senior portfolio manager with Sprott Asset Management Inc.of Toronto and manager of Sprott Opportunities Hedge Fund LP, sees opportunities in shorting the shares of the big Canadian banks as credit and economic problems continue to unfold. Although the Canadian banks have held up better than many banks in the U.S. and Europe, he says, they may still feel the impact on their business.

In addition, Tardif is concerned that U.S. consumers — who account for 70% of U.S. economic growth — will reduce their spending in the face of tighter credit conditions and the loss in value in their homes and investments. He is keeping an eye open for timely opportunities to go short on consumer-sensitive companies such as car manufacturers, retailers and electronics manufacturers.

“In volatile times, it’s necessary to be more flexible,” Tardif says. “We buy the stocks we like when markets are down, and short the ones we don’t like after a strong rally.”

Exchange-traded futures contracts also present opportunities for short-sellers. Michael Hart, senior trader with Toronto-based Friedberg Mercantile Group Inc.,has made profits by being short on the Canadian dollar during its recent rapid descent against the U.S. greenback. However, being nimble is the key.

Hart believes that with the massive liquidity injections and lowering of interest rates in the U.S., the stage is being set for an eventual devaluation of the US$ and for inflation.

“Gold is a tangible asset,” says Hart. “It represents real money and will do well in an inflationary environment. The US$ is overbought, and being long on gold will be a great play.”

Jason Russell, vice president of Toronto-based Salida Capital Corp. and manager of Salida Global Macro Hedge Fund, has also used futures contracts to manage risk and dampen volatility in client portfolios.

He has done well during the market rout by shorting cotton, copper, gold, the C$, the British pound sterling and long bonds. Because of extreme volatility, Russell is keeping initial positions small, limiting any one position to a quarter of a percent of his fund.

“A small position can quickly become a big position,” he says, “with the way the market is moving.” IE