It has been some time since we last saw a reasonably sized pullback in the U.S. markets. We all know it is just a matter of time before it happens, and the latest moves in a number of the high-flying tech stocks have the chatter mills going into overdrive. 

While the markets remain robust, it is a good time to consider alternative strategies that could help mitigate downside volatility. Two strategies, I believe, are particularly relevant today: PUTW, the WisdomTree CBOE S&P 500 PutWrite Strategy Fund, and DYLS, the WisdomTree Dynamic Long/Short U.S. Equity Fund.

Option #1 for Managing Downside Risk: PutWrite Strategy Fund

Those who believe the upside gains in the market are limited should consider a put-write strategy fund like PUTW that effectively sells at the money put options on a monthly basis and collects the option premiums—capping upside participation in the market but historically protecting on downside. Especially if the down market that inevitably arises brings with it a rise in volatility, the option premiums collected by PUTW are apt to increase from today’s low levels. Downside risk, of course, will bring losses on option premiums, but over time we believe this strategy has the potential to garner market-like, S&P 500 returns as a function of the option premiums PUTW can collect, and it can do so with lower volatility levels.

Option #2: Long/Short ETF

Low-cost 1, daily-liquidity, alternative strategy funds are one of the areas where I see exchange-traded funds (ETFs) continuing to develop innovative solutions. At the end of 2015, WisdomTree launched DYLS, the WisdomTree Dynamic Long/Short U.S. Equity Fund. This Fund utilizes a dynamic market-hedging indicator and a rules-based index strategy that determines its exposure to the equity markets.  

DYLS was fresh out of the gate and fully hedged in January and February 2016. It was a volatile time in the equity markets and a good time to have a market-neutral hedge in place. DYLS went unhedged in 2016 after the market close on March 2 and remained unhedged for the remainder of 2016 aside from November, adding a 50% hedge ratio just this June. This half hedge on the market was based on the earnings momentum component of the model losing steam and valuation levels being stretched, with the recent strong earnings gains coming up against tougher competitive benchmarks from past metrics. 

I believe both of these funds are expected to have lower beta and market risk—strategies that are worth considering with markets at highs and widespread discussions concerning valuations of the U.S. markets.

• At least as of this June, DYLS’ net equity position has a 0.5 beta, and its beta since its launch, interestingly enough, has also been 0.5. But this 0.5 beta makes it one of the top performers in the entire category of long/short funds, beating 99% of its peers since inception. What I really like about the long/short strategy is that this fund also has lower market multiples and higher tilts toward quality stocks—which could also be beneficial in any market volatility environment.

• Option Writing Category: PUTW was launched three months after DYLS and has 15 months of real-time performance. Since its inception, PUTW has beaten 77% of its peers in the Morningstar Option Writing category, with a cumulative performance advantage of 380 basis points (bps) over its Morningstar peer group category average.

In summary, both of these funds are options for investors considering how to manage downside risk in the equity markets. Both strategies are designed to lower equity beta while also achieving long-run equity market upside participation. 

1Ordinary brokerage commissions apply.