when people talk about volatility, it's usually seen as negative, a destroyer of wealth. In this video, we'll look at how we can turn that on its head and see three ways to turn volatility into a way of increasing your returns. This video is sponsored by Saxo, an award-winning UK investment platform. Beside me, you can see a table of volatilities for various investments. This is a typical annual percentage price move for these investments, so you shouldn't be surprised if the price of one of these investments moves up by its volatility. That's what typical means. So, for example, for cryptocurrency, a 70% one-year move is absolutely normal, whereas for a money market fund, you'd expect a less than 1% annual price move to be normal. Generally, you'd expect equities to be more volatile; they're further up on the table than fixed income bonds, which tend to be less volatile investments depending on their duration. But generally, when you see these tables of volatility, it's described as a bad thing, something to be avoided or diversified away, whereas in

fact you can make money out of volatility. Now, you probably remember at school you were taught about something called standard deviation. What if I told you that standard deviation, or volatility as we call it in finance, is something that you can buy and sell? Well, that's the way it is. If you trade derivatives, you can actually buy and sell volatility, and the time you choose to sell it is when it's expensive. Now, for a professional investor, they can sell volatility via selling options directly. However, for most retail investors, certainly in the UK, that's not possible. So, what we can do instead is to buy a fund which sells options, and that way we can pocket the premium from selling those options and boost our income. So, let's look at some of these funds where you can sell volatility. Now, this is generally called a yield enhancement strategy because by selling something, you're boosting your income. So, the fund manager will take an index, say the S&P 500, and then they'll sell options on that index. They'll sell the upside, for example, with a call option to

somebody else, and they'll pocket the premium, which is then passed on to their investors in the form of a dividend. Now, at the same time as selling the upside, you actually buy the index itself. So, what you end up with is something that looks like a hockey stick, where the upside is capped, and you keep all of the downside. And that's called a BuyRight. You've bought an index, and you've sold the upside. Now, you might be thinking, That sounds really toxic. I've sold the upside. I've kept all the downside. The reason why you do it, of course, is because of that income, and that's why if you compare the payoff, as you can see beside me here, with just buying the index, it's kind of shifted upwards by that premium. Now, options come with an expiry date, which means that the fund manager will have to regularly sell them, usually monthly, and then that generates your monthly dividend. Now, this BuyRight strategy, you buy the index and write an option or sell an option, has an index in

the United States called the bought index for the S&P 500, and this allows you to backtest the strategy, at least theoretically, going all the way back to 1988. So, what I've got here is a comparison between a total return index for the S&P 500 versus its bought index, where you're continually selling the upside and pocketing the income that's generated. In the bottom panel, I've divided the bought index by the S&P 500's total return. Notice that for a very long period of time, from 1988 all the way up to 2010, the two were roughly in line with each other. However, after 2010, there was a very marked underperformance of this bought strategy. The reason for that is because there were such incredible capital gains for the S&P. Remember, what we've done with the bought is to sell the upside to someone else. So, the worst possible environment for a bought strategy is when you've got a very rapidly increasing underlying index. Now, this strategy has

become very popular recently because presumably people are thinking, Well, the United States is looking very toppy, very overvalued, so I think it'll probably ease off on its capital growth for a while, and it'll remain volatile. That's the key thing, which means that selling the options will give me a very high coupon while still being exposed to the S&P. So, if we look at that same data, but we look at returns annually, and here you can see the S&P returns on the x-axis and the bght strategy on the y-axis, the line of identity is the dashed yellow line, and I've highlighted the years in which the bght strategy underperformed in red and the ones where it outperformed in blue. Notice that the blue years when the bght strategy outperformed was when the index was either trending upwards slightly or sideways or downwards because that's when the income tends to soften the blow. The years when it gave the greatest underperformance was when the S&P 500 had its highest returns, and that's

because of the fact we've sold the upside. So you can see the attractiveness of this buy-write strategy right now. People don't believe in the upside as much as they did for the S&P or maybe even the NASDAQ, so they're quite happy to sell that upside to somebody else and pocket the premium today. Now, in the UK, you can buy buy-write funds, ETFs, and these are from Global X, for example. This is not a recommendation, of course, but you can see the attractiveness here because for the NASDAQ index, which is very volatile, the current dividend yield for this fund, QLD, the Sterling denominated version, is QP. The dividend is 12.2%, which is very high and a very attractive yield. For the S&P, which isn't quite as volatile, the current dividend yield is about 99.7%, but still much higher than you'd get simply by buying the S&P. So both of these ETFs have a version which ends in P because it's Sterling denominated. That's QY LP and XY LP. Now there are

also active funds, which use this option-selling strategy to enhance income. For example, a very popular one in the US, and this is run by JP Morgan Asset Management, is called JEPPY. The ticket is JEI, and this is actively managed. The idea here is that JP Morgan selects stocks. It buys those stocks in the S&P 500, which it thinks have the greatest upside potential, and at the same time, it sells call options on the ones which it doesn't think are going to go up as much or which are very volatile. Remember, that's what gives the highest option premium if a stock is very volatile. In fact, the US is spoiled for choice because it has 307 ETFs by right ETFs listed on Vertify. I've just shown the top 10 here in terms of assets under management, and you can see QD and XYLD there as well. So, you can certainly enhance your income by using these bought strategies and buying a fund which implements them. However, as always, if you don't understand it, don't buy it. Today's video is sponsored by

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offering you an exclusive welcome bonus. Open an account and receive up to £200 back on online trading fees to help you get started. This offer is valid for a period of 3 months after your first trade. This offer cannot be used for FX, FX options, CFDs, CFD options, and CFD indices. To learn more, just go to the link in the description below. The second thing you can do to monetize volatility is simply to carry on saving and investing, and that's particularly true if you're early in your savings journey. And that's because early on, volatility is much less important than it is when you've got a large amount of savings. Let's illustrate that with a really simple example where we've got a 30-year investment period. Every year, we get 6% return steadily, except for one awful year, and that awful year happens either at the beginning of our investment period or at the end of it. Now, the compounded returns are identical in these two scenarios: 6% for 29 years and one year with a 30% fall. But because

we have less savings when we start off. A 30% crash really doesn't matter that much, of course. We'll underperform until we get to the end of the period. However, the crash at the end of the period is really much more destructive of wealth because we've got more wealth. This is often why people de-risk just before retirement to avoid this, and it's called sequencing risk. But what sequencing risk means for saving is that volatility at the beginning of your investment journey matters a lot less than volatility at the end of it. And there's another reason why a crash in the beginning or in the mid-part of your savings journey is really helpful. In fact, you should be kind of hoping for it. And that's because valuation really matters for return. This is a report from Vanguard. You often see these graphs shown, but this is just one example of it, which looks at the starting price-to-earnings multiple for US stocks and for international stocks, and then it tracks the returns over the following decade. Notice how when valuations are high, the subsequent

returns are low because you've overpaid for stock. Whereas if you buy stock when they're cheap, the long-term returns tend to be higher. The point they were making in this Vanguard research note was that international stocks were cheaper than US stocks, so you'd expect a higher return for them. But equally, if you're someone who, say, in your 20s, 30s, even your 40s, and markets have crashed, then you're buying stocks as you save and invest at a much lower multiple, and that means higher returns long-term. So, this is another reason why during periods of market volatility, when there's a crash, then it's usually a good idea to carry on investing. In fact, if you possibly can, you'd actually save more. And our final way of profiting from market volatility is related to the previous one, and that's rebalancing. The idea here is that you have some long-term allocation in your portfolio. To put it at its simplest, it could be 60% stocks, 40% bonds. And then when you deviate from that because stocks have

rallied and bonds haven't. Then once you reach a certain deviation distance from your target weights. So you started off at 60/40 and now you're 70/30. Then you rebalance. You sell some stocks which have risen and you buy some bonds which haven't. Which on the face of it seems like a very odd thing to do. You're selling your winners and buying your losers. But back tests show that this strategy actually works reasonably well. So here's a simple example of how that would work in practice. If we've got a 60/40 portfolio in the top panel. The red line shows you cumulative stock returns. The blue line is cumulative bond returns. And then our 60/40 strategy portfolio is shown in yellow. Now in the bottom panel what I've done is I've shown you what proportion of the portfolio is invested in stocks. Notice how that doesn't stay constant because we're not continually rebalancing. What we're doing is just waiting until our stocks touch some kind of threshold. If they go up to 70% stocks.

30% bonds because they've rallied, then we'd sell some stocks, and that takes us straight back to 60%. And if stocks fall in value such that the allocation falls to 50% stocks, 50% bonds, then we buy some stocks. So again, we snap back to that 60% allocation. So the dashed white lines that you can see here are when those allocations occurred. The first one occurred in 2008 when equity markets tanked. In the US, equities fell, the allocation to equity fell as well, then it touched that 50% mark, and we sold some bonds to buy equity. And that makes good sense because stocks were then very cheap. It was an incredible opportunity. But then what happened was a very sharp rally in equity, which we bought cheaply, and you can see that then we touched the 70% boundary. So at that point, we sell some stocks and we buy some bonds. We bag some of our profits, in other words. And in fact, all of the rebalancing that happened after that were during the

stock market rallies, and what they involved was selling equity to buy some bonds. Now, there's been quite a lot of research published on whether it's worthwhile rebalancing, and the general result is yes, it is, and it doesn't make a huge difference, but generally, if you do it infrequently because it's an effort, and it also sometimes incurs trading costs or capital gains tax realizations if it's outside a tax-sheltered account, then it tends to outperform. So, for example, here's a research note by T. Rowe Price, and you can see that the outperformance is based on the allocation of the portfolio, and here we've got a 30%, 60%, and 90% equity portfolio. The rebalancing pays off, although the differences are not huge. So, for example, for the 30% equity portfolio, if you use these fixed bands where you deviate, say, 3% from your target allocation, then the difference in mean return is not huge. It's between 5.57% and 5.52% without rebalancing in bear.

markets you can see the difference is bigger so there it's 5.72 and 5.32 so really it's during these periods of really large market moves where these rebalancing can actually add a bit of return to your portfolio. So those are three ways in which I think you can actually make money out of volatility. And I think having a market crash shopping list, which is another video I make about volatile periods, is a good way to make use of these offs to buy the stuff you really want and also buy them at bargain prices. Now don't forget our offer from Saxo. They're offering a welcome bonus for PensionCraft viewers, which is worth up to £200 back on your online trading fees. But of course, terms and conditions apply. And if you want to learn more about that, you'll find more details in the link below. And as always, thank you for listening.

Profiting From Stock Market Volatility

My name is Ramin Nakisa and I started PensionCraft in 2016 as I felt strongly that I wanted to teach people how to invest well for themselves so they could stop making costly mistakes and losing their money through having to pay unnecessarily high fees.

Before starting PensionCraft, I worked in investment banking as a strategist and I was a frequent contributor on CNBC and Bloomberg TV. I have written two books about finance and investment: one for professional investors and one that explains how to buy and sell volatility using exchange-traded products.

I publish a new video on YouTube every Saturday and you can join me for a live Q&A on the 1st Thursday of every month at 7pm UK time.

If you want to learn how to become a better investor then why not join our friendly membership at pensioncraft.com?
