What is an Overlay?

Shawn Gibson

21 November 2019

The term “Overlay” has been used multiple ways in the investment management industry, but when we think of the term, we envision a fully-invested investment portfolio with an options-based strategy that sits on top of the portfolio. This overlay effectively converts a two-dimensional investment portfolio into a three-dimensional portfolio where the 3rd dimension (the options overlay) alters the risk/reward profile of the overall combined portfolio. Investors that utilize overlays generally do so with the goal of reshaping the potential investment outcomes with the most common goals being 1) generating supplemental income/return (typically through covered call or put writing strategies); and 2) reducing the risk of the existing portfolio beta exposure (typically through collar strategies).

Option overlays can be very attractive to investors not only because they can help create more desired outcomes, but they are also highly capital efficient. Implementing an overlay does not require any changes to the existing portfolio, thus eliminating the need to make asset allocation changes and without triggering capital gains in the holdings. Once the overlay is designed and implemented, the total return for the investors goes from just the returns of the original holdings to the returns of the holdings plus the returns of the options overlay. 

For investors looking to go beyond market beta exposure or that have seen little value in actively managed strategies, overlays could be a nice addition. Overlays have been used for years by large sophisticated investors such as pension plans, sovereign funds and endowments. However, many wealth clients have not been able to access these strategies due to some of the operational complexities advisors face with offering them to clients. Liquid Strategies is working with advisors and their clients to fill this void by offering packaged solutions that provide access to overlay strategies in a very simple way with very low minimum investments, democratizing a valuable strategy previously reserved for the largest investors.

Learn more about Liquid Strategies and our offerings.

The assertions and statements in this blog post are based on the opinions of the author and Liquid Strategies. The examples cited in this paper are based on hypothetical situations and should only be considered as examples of potential trading strategies. They do not take into consideration the impact that certain economic or market factors have on the decision making process. Past performance is no indication of future results. Inherent in any investment is the potential for loss. Options involve risk and are not suitable for all investors. Please see the following options disclosure document (ODD) for more information on the characteristics and risks of exchange traded options.    

Shawn Gibson

Shawn Gibson co-founded Liquid Strategies in 2013 and serves as the Chief Investment Officer and Portfolio Manager.