Look at most equity funds or, for that matter, read the marketing material of most money-management firms, and you will see that value investing is very much in style. Look at good quality, well-managed companies that pay dividends, and try to buy them at a discount.

It sounds pretty good. It allows one to conceptualize a buy-and-hold approach, less portfolio turnover — that’s good — and over the long term it has proven to get clients where they want to go. Who could argue with Warren Buffet’s philosophy? (To be fair, Buffet’s Berkshire Hathaway Inc. is really about private equity investing with a value kicker. But I digress.)

Let’s accept that value investing is a good strategy. Although, to be a true value investor, you must be willing to accept lengthy periods during which portfolio returns are dampened or even stagnant. Microsoft Corp., General Electric Co. and Pfizer Inc. come to mind. All excellent companies, paying good dividends — I am counting Microsoft’s special dividend as part of its two-year dividend payout — and none that have done much lately for long-term investors.

Typically, value stocks experience little volatility, the definition of volatility being the annual standard deviation of returns. Standard deviation measures the degree to which the underlying security moves up or down over defined periods. It is the tool of choice to measure risk. The higher the standard deviation, the greater the risk.

A value stock that pays a decent dividend is not particularly volatile and, therefore, not as risky. That may or may not be true, but it is how the industry rationalizes why investors buy value and why money managers market value. But that only tells half the story.

A stock’s volatility pattern will increase whether the stock rises or falls. Yet, for an investor, it is only a problem when a stock moves to the downside. That means, for average clients, the only true metric is downside volatility.

For advisors who trade options, there may be a way to deal with the value approach while using high-beta stocks. A high-beta stock will be more volatile, which will translate into high option premiums.

Another approach advisors may consider is to look at high-beta stocks with a higher volatility metric, which, because of the way options are priced, means higher option premiums — something value stocks do not have. At least with higher option premiums, you can write covered calls and collect income while you wait.

You could also argue the cash flow from the option premium is worth more than the higher dividend income typical of value stocks, especially for Canadian investors who hold U.S. high-dividend-paying value stocks. Premium income is taxed as a capital gain whether on a U.S. or a Canadian stock, while dividends from U.S. companies do not receive preferential tax treatment in Canada.

I have personally experienced this with my managed portfolios. At least with high-beta stocks (another word for more volatility) I have — excuse the pun — options.

Take the Chicago Mercantile Exchange (recent price US$567.96) as a case in point. The stock, like most of the publicly traded stock exchange groups, has been a serious mover in the past few years — both up and down, more down in the past few weeks.

From a value manager’s standpoint, it is difficult to justify an investment in a high-priced stock with a high P/E multiple. On the other hand, the volatility has made it an excellent candidate for covered call writing. Even if you bought prematurely, that is, just before it started to decline.

I purchased CME recently in my pool at US$600. The purchase was the result of an assignment from a short $600 put option. At that price, I bought near a recent high, although the premium from the put sale made my adjusted cost somewhat lower.

Since then, I have written two consecutive call options, both at lower prices, and have reduced my out-of-pocket cost for the stock to the US$550 range. It may or may not get called away at US$560 in April, which is the option I am currently short. But even at that price, I have made a return that beats most value managers holding “value stocks” that are simply treading water and paying dividends.

@page_break@Covered call writing allowed me to deal with volatility in a meaningful way. With most low-volatility value stocks, that is not an option. From my perspective, it makes more sense to build stock portfolios with a back-up plan.

In my case, the back-up plan is covered call writing. IE