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Although the U.S. stock market saw a blockbuster start to 2018, it was on a bumpy ride last month. In fact, major bourses slipped into the correction territory early February and are yet to recoup all losses, except Nasdaq (read: 5 Tech Stocks Lifting the Nasdaq ETF to New High).
The threat of rising inflation, fears of faster-than-expected rate hikes, a brewing trade war and now the political drama have kept investors on the toes. Volatility is expected to rise in the coming weeks as President Trump's decision to slap tariffs on imported steel and aluminum might lead to retaliation from other countries.
Additionally, Trump seeks to impose tariffs on up to $60 billion of Chinese imports, targeting the technology and telecommunications sectors. Further, the dismissal of Secretary of State Rex Tillerson after a series of public rifts over issues including North Korea and Russia led to new tensions (read: Trump Tariffs: ETF Winners & Losers).
Amid the political tensions, the fundamentals remain bullish given solid corporate earnings and accelerating global economic growth. The euphoria surrounding the tax reform has been the biggest catalyst this year, as it will perk up the economy and save billions for corporations, leading to reflation trade and higher earnings. Further, increased consumer spending, rising consumer confidence, 17-year low unemployment, and a pickup in average hourly earnings are bolstering confidence in the economy and the nine-year old bull market.
In such a backdrop, investments that provide capital appreciation opportunities with minimum downside risks are in demand. A gainful option for now could be the ‘Buy-Write’ strategy.
Buy-Write Strategy in Focus
A buy-write is an option strategy that involves buying a stock or a basket of stocks and then selling or writing call options on those assets. With this process, the portfolio aims to generate additional monthly income from the call option (premiums collected). If the product stays flat or declines slightly, investors keep the premium and their stock. However, if prices rise, investors only receive the premium and the stocks are sold at the price that was agreed upon on the covered call. As such, the strategy outperforms in neutral to bear markets and underperforms in bull markets over the short term.
Given the market uncertainty, investors seeking to make a play on the stocks using this strategy could consider the following ETFs (see: all the Large Cap ETFs here):
This fund tracks the CBOE S&P 500 BuyWrite Index, which measures the performance of a hypothetical buy-write strategy on the S&P 500 index. This strategy includes holding a long position of the stocks in the S&P 500 and selling a succession of covered call options, each with an exercise price at or above the prevailing price level of the S&P 500 index. The fund has amassed $302.9 million in AUM and trades in average daily volume of nearly 100,000 shares a day. The product is a bit expensive when compared to other choices, charging 75 bps in annual fees. The ETF has an annual yield of 4.89% and has gained 4.5% in a month.
This ETF follows the CBOE NASDAQ-100 BuyWrite V2 Index, which is designed to buy a NASDAQ-100 stock index portfolio, and writing (or selling) the near-term NASDAQ-100 Index covered call option, generally on the third Friday of each month. The product has $194.6 million in AUM and trades in moderate volume of more than 55,000 shares a day on average. Expense ratio came in at 0.60% and annual dividend yield is higher at 8.09%. QYLD has risen 5.7% over the past month (read: Low Beta ETFs to Buy as Bulls Play Hide & Seek).
Horizons S&P 500 Covered Call ETF
This ETF seeks to match the performance of the CBOE S&P 500 2% OTM BuyWrite Indexs, which buys a S&P 500 stock index portfolio while at the same time writes (or sells) the near-term S&P 500 index covered call option, generally on the third Friday of each month. The fund has amassed $45.7 million in its asset base and charges 65 bps in fees per year. Volume is light as it exchanges around 5,000 shares in hand on average daily basis. The ETF has 5.54% in annual dividends and has gained 5.3% in a month.
iPath CBOE S&P 500 BuyWrite Index ETN
This is an ETN option and tracks the similar index as that of PBP. Unlike PBP, the ETN carries credit risk from the issuing institution — Barclays. The note is less popular and less liquid as depicted by its AUM of $8.5 million and average volume of under 1,000 shares. The ETN charges 0.75% in fees and expenses and has added 2.8% in a month.
Bottom Line
These products seem appropriate for investors seeking high levels of income and a hedged exposure to large-cap U.S. equities. It is worth noting that the funds will significantly during a booming period but will be an appealing pick during flat or declining market conditions, especially for investors seeking extra income in a volatile environment.
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BuyWrite ETFs for a Topsy-Turvy Market
Although the U.S. stock market saw a blockbuster start to 2018, it was on a bumpy ride last month. In fact, major bourses slipped into the correction territory early February and are yet to recoup all losses, except Nasdaq (read: 5 Tech Stocks Lifting the Nasdaq ETF to New High).
The threat of rising inflation, fears of faster-than-expected rate hikes, a brewing trade war and now the political drama have kept investors on the toes. Volatility is expected to rise in the coming weeks as President Trump's decision to slap tariffs on imported steel and aluminum might lead to retaliation from other countries.
Additionally, Trump seeks to impose tariffs on up to $60 billion of Chinese imports, targeting the technology and telecommunications sectors. Further, the dismissal of Secretary of State Rex Tillerson after a series of public rifts over issues including North Korea and Russia led to new tensions (read: Trump Tariffs: ETF Winners & Losers).
Amid the political tensions, the fundamentals remain bullish given solid corporate earnings and accelerating global economic growth. The euphoria surrounding the tax reform has been the biggest catalyst this year, as it will perk up the economy and save billions for corporations, leading to reflation trade and higher earnings. Further, increased consumer spending, rising consumer confidence, 17-year low unemployment, and a pickup in average hourly earnings are bolstering confidence in the economy and the nine-year old bull market.
In such a backdrop, investments that provide capital appreciation opportunities with minimum downside risks are in demand. A gainful option for now could be the ‘Buy-Write’ strategy.
Buy-Write Strategy in Focus
A buy-write is an option strategy that involves buying a stock or a basket of stocks and then selling or writing call options on those assets. With this process, the portfolio aims to generate additional monthly income from the call option (premiums collected). If the product stays flat or declines slightly, investors keep the premium and their stock. However, if prices rise, investors only receive the premium and the stocks are sold at the price that was agreed upon on the covered call. As such, the strategy outperforms in neutral to bear markets and underperforms in bull markets over the short term.
Given the market uncertainty, investors seeking to make a play on the stocks using this strategy could consider the following ETFs (see: all the Large Cap ETFs here):
PowerShares S&P 500 BuyWrite Portfolio (PBP - Free Report)
This fund tracks the CBOE S&P 500 BuyWrite Index, which measures the performance of a hypothetical buy-write strategy on the S&P 500 index. This strategy includes holding a long position of the stocks in the S&P 500 and selling a succession of covered call options, each with an exercise price at or above the prevailing price level of the S&P 500 index. The fund has amassed $302.9 million in AUM and trades in average daily volume of nearly 100,000 shares a day. The product is a bit expensive when compared to other choices, charging 75 bps in annual fees. The ETF has an annual yield of 4.89% and has gained 4.5% in a month.
Horizons Nasdaq 100 Covered Call ETF (QYLD - Free Report)
This ETF follows the CBOE NASDAQ-100 BuyWrite V2 Index, which is designed to buy a NASDAQ-100 stock index portfolio, and writing (or selling) the near-term NASDAQ-100 Index covered call option, generally on the third Friday of each month. The product has $194.6 million in AUM and trades in moderate volume of more than 55,000 shares a day on average. Expense ratio came in at 0.60% and annual dividend yield is higher at 8.09%. QYLD has risen 5.7% over the past month (read: Low Beta ETFs to Buy as Bulls Play Hide & Seek).
Horizons S&P 500 Covered Call ETF
This ETF seeks to match the performance of the CBOE S&P 500 2% OTM BuyWrite Indexs, which buys a S&P 500 stock index portfolio while at the same time writes (or sells) the near-term S&P 500 index covered call option, generally on the third Friday of each month. The fund has amassed $45.7 million in its asset base and charges 65 bps in fees per year. Volume is light as it exchanges around 5,000 shares in hand on average daily basis. The ETF has 5.54% in annual dividends and has gained 5.3% in a month.
iPath CBOE S&P 500 BuyWrite Index ETN
This is an ETN option and tracks the similar index as that of PBP. Unlike PBP, the ETN carries credit risk from the issuing institution — Barclays. The note is less popular and less liquid as depicted by its AUM of $8.5 million and average volume of under 1,000 shares. The ETN charges 0.75% in fees and expenses and has added 2.8% in a month.
Bottom Line
These products seem appropriate for investors seeking high levels of income and a hedged exposure to large-cap U.S. equities. It is worth noting that the funds will significantly during a booming period but will be an appealing pick during flat or declining market conditions, especially for investors seeking extra income in a volatile environment.
Want key ETF info delivered straight to your inbox?
Zacks’ free Fund Newsletter will brief you on top news and analysis, as well as top-performing ETFs, each week. Get it free >>