Here's a look and the best and worst returns among open-end stock mutual funds that can invest in option contracts.
If your mutual fund is allowed to trade in options or other derivative security instruments, the returns may be dramatic or traumatic.
Trading in option contracts, it is possible to lose all your money and more. However, if these derivatives, whose value is based on the movements of underlying security or commodity prices, are used as an insurance policy to hedge against larger losses, they can be beneficial.
There are also less-risky covered call strategies that allow funds to create and sell call-option contracts. In writing these options, a premium is collected, while the underlying shares are held in the fund's portfolio. The fund hopes the underlying share price will remain below the strike price of the call option so that at expiration the option would have no intrinsic value and expire worthless.
If the stock does rally, the speculator who bought the call option could exercise that option, "calling away" or purchasing the shares at the agreed upon strike price in the contract. The fund loses the appreciation in the shares and can lose money on the trade if the shares climb above the sum of the strike price plus the premium collected.
The best performing "option" fund we track is the
Direxion Commodity Bull 2X Fund
, which has soared 62.20% for the year ending April 30. The fund uses a variety of securities including stock index futures, swaps and option contracts to attempt to capture twice the return of the Morgan Stanley Commodity Related Index. With the index up 35.97% over the same period, the fund's return is spectacular but lags its 200% goal.
Rydex Series -- Commodities Strategy Fund
also invested its shareholders' assets into options and futures, as well as options on futures contracts, hauling in a respectable 47.93% in the last year.
Futures contracts allow speculators and hedgers to control large quantities of the underlying commodities at only a fraction of the final potential cost. Each day the change in value is either added or subtracted from the investor's account. Therefore, options on futures contracts multiplies the leverage and the chance for big gains or losses.
This leverage worked against the
Direxion Small Cap Bull 2.5X Fund
. While the Russell 2000 Index slid 10.95% over the last 12 months, this fund crashed 36.80% so the options and other derivatives are working exactly as expected.
Touchstone JSAM Large Cap Value Portfolio
is allowed to use futures and option contracts to hedge market exposure. After losing 36.52% in a year, the effectiveness of its hedging program ought to be re-evaluated.
For an explanation of our ratings,
Kevin Baker became the senior financial analyst for TSC Ratings upon the August 2006 acquisition of Weiss Ratings by TheStreet.com, covering mutual funds. He joined the Weiss Group in 1997 as a banking and brokerage analyst. In 1999, he created the Weiss Group's first ratings to gauge the level of risk in U.S. equities. Baker received a B.S. degree in management from Rensselaer Polytechnic Institute and an M.B.A. with a finance specialization from Nova Southeastern University.