The performance of the stock market this past year has been stellar, and 2011 is looking good thus far. But many of your clients are still shaking on the sidelines, which is typical behavior for small investors in prior post-recession bull markets. Rudy Aguilera has a possible solution for getting them back into the market.

Aguilera is chief investment officer and co-portfolio manager of the Ironclad Managed Risk Fund (IRONX), which promises a slightly better return than the S&P 500 with less volatility. "We looked at the motivation of investors when they buy risky assets," says Aguilera. "They want a big return down the road, but to get there they have to ride out all of the interim volatility. Investors can avoid a portion of that volatility by repositioning their portfolio and still, over the long term, get their desired rate of return."

Aguilera points to the Chicago Board Option Exchange's S&P 500 PutWrite Index, a passive investment strategy that systematically sells one-month put options on the S&P 500 that are collateralized by Treasury Bills. The index has beaten the long S&P 500 handily over time with less volatility. From July 1986 to December 2010, the S&P 500's annualized total return was 9.30%, with a standard deviation of 16.14%; the PutWrite Index had a 10.59% annualized gain, with a standard deviation of just 10.83%.

"You do add value by generating an equivalent return with less risk," says Aguilera. For example, an investment of $100,000 made 25 years ago in the PutWrite Index would today be worth $1.18 million, compared to only $884,504 for the S&P 500 with dividends reinvested.

"Obviously, when the market's on a tear, as it was during the tech bubble of the late 1990s, the unhedged S&P 500 will have higher returns," Aguilera says. "But when you look longer-term, over an entire market cycle, you tend to replicate the returns of the S&P 500 with less risk through the PutWrite Index." When the S&P 500 closed at its nadir of 676.53 on March 9, 2009, it had to generate over 130% to regain its high of 1565.15 on October 9, 2007. The PutWrite Index required a 64% return to break even over the same period, he explains. "While the S&P 500 still sits well below its 2007 highs, the PutWrite Index finished 2010 at an all-time high."

Aguilera has replicated the PutWrite Index in his newly created IRONX fund. It functions somewhat like a covered call strategy. Both require the seller of the option to have two positions. But in a cash-secured put strategy, one position is made up of Treasury Bills and the other is put options sold against the Treasuries.

When IRONX sells the monthly put option, it pockets the proceeds, or premium. If the index is above or at the strike price when the option expires, the put is worthless and IRONX's gain is limited to the premium. This is what the fund would receive in rising or sideways markets.

If the index is below the strike price when the option expires, the fund has to buy the index at the strike price and take the loss, but this is offset by the cash received from selling the put. The more volatile the market, the higher the proceeds from the put sale. "Put options monetize the market's fear premium," Aguilera explains. "During periods of market stress, investors' demand for downside protection drives up the prices of put options." The higher premium from selling the put helps offset any losses in excess of the premium collected.

Say you want to allocate to large caps through a put-writing strategy when the S&P 500 is trading at 1300; a 30-day put option with a 1300 strike price may be trading at $30. Each contract has a 100 multiplier, so each represents $130,000 of exposure (1300 strike price x 100). Consequently, $130,000 of 90-day T-bills would be purchased to back the options. These ensure that the fund can pay for the index on which it sold puts, if those puts are exercised.


"If the market stays at or above 1300 at expiration, we retain the $3,000 put premium, since the purchaser of the put option would have no reason to exercise it and it would simply expire," says Aguilera. "The result is a gain of 2.3% ($3,000/$130,000). That income, plus the interest on the T-bills, is the most we can make over the life of the option. If, on the other hand, the market drops 5% to 1,235, the put option would be worth $6,500, since the holder has the right to the difference between 1,235 and 1300 multiplied by 100," says Aguilera. "Instead of being down 65 points in the S&P 500 (a loss of 5%), IRONX is down only 35 points because we sold the puts for $3,000, and we owe the purchaser a cash payment equal to $6,500 for a loss of 2.7%."

The strategy is virtually identical to a covered call strategy, but is less costly because the former involves numerous commissions on both the stocks and the call options, says Aguilera. With an index put-writing strategy, there is just a single commission on the put option. And 60% of the income generated is considered a long-term capital gain, 40% is a short-term capital gain, regardless of your holding period. "In an equivalent covered-call strategy where you buy a stock or ETF and sell a call against it, the premium income generated is taxed at short-term capital gain rates," he says. For an investor in the 35% bracket, the difference is a lower blended tax rate of 23% versus 35%.

Ronald Groenke, an investment advisor and author of "Show Me the Money: Covered Calls and Naked Puts for a Monthly Cash Income," says that the strategy articulated by Aguilera is "excellent," but while the downside protection works in theory, there's no guarantee in practice. "He's really selling covered puts on ETFs," Groenke says. "If you have another market crash, unless he really manages his positions, he'll end up taking ownership of all those ETFs, and at a higher price than they're trading at. So managing it on the way back up would be critical. "He'd have to sell covered calls as the market recovers. It would be important for him to pick the right ETF sectors at the right time."

Additionally, Groenke notes that, the fund, which debuted last October, "doesn't have any history, so it's hard to say yet how well he'll do at this over time."

Although IRONX is new, it has already amassed $70 million in assets. Since its inception last October, it has gained 5.11% through Dec. 31, with a standard deviation of 5.74%. Over the same period, the S&P 500 returned 7.14% with a standard deviation of 11.76%. The concept assumes the investor buys IRONX as a longer term holding, since over shorter periods, it can underperform the S&P.

While the fund is new, the PutWrite Index has a history going back 25 years, and Aguilera has a strong background in managing reduced-risk investment portfolios. Seven years ago, he founded Helios, an independent Registered Investment Advisor that managed investment portfolios as an outsourced solution for other advisory firms. Five years ago, he was asked by the Chicago Board Options Exchange (CBOE) to create and teach a course on risk management for institutional investors, advisors and planners, which he continues to teach while acting as a principal of IRONX.

The fund is not for everyone, but "it can serve as a reduced-risk equity substitute, or as a low-volatility core for an asset-allocation model that allows investors to take on additional risk with other allocations," says Aguilera. IRONX is distributed exclusively through financial advisors. Advisors who are interested in learning more can do so at

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