Making the Case for a Put Write ETF

 |  Includes: DIA, PBP, QQQ, SPY
by: Roger Nusbaum

Quite a while back I wrote a post or two about the S&P 500 Put Write Index (which has symbol PUT), which is a fairly new index that is based on selling naked index puts along the lines of the S&P 500 Buy Write Index (which has symbol BXM). If you look at a long term chart for BXM, these are easy to find, you will see that BXM has done a good job of smoothing out the ride. The link above only goes back a little over five years, but if you can find a chart that goes back to the late 1990s you'll see it smoothed out the ride during the tech decline while lagging in the bubble build up.

You can go to the CBOE website for more information on PUT, and there you can see that BXM outperformed the S&P 500 but that PUT outperformed BXM. If you click through you will also see that PUT had a lower standard deviation than BXM, which had a lower standard deviation than SPX. Below is a chart from the CBOE that captures a very long term backtest of PUT. (Click charts to enlarge)

There is an ETF that tracks BXM -- the PowerShares S&P 500 BuyWrite Portfolio (NYSEARCA:PBP) -- which a few clients own but there is no Put Write ETF. However, IndexUniverse reports that one might be on the way. Sort of.

The U.S. Equity Synthetic Reverse Convertible Index Fund (proposed symbol RVCT) will sell cash secured puts on the 12 most volatile stocks in the S&P 500. The IU article says 13 stocks but the prospectus says 12.

The fund will not sell exchange listed puts but special over the counter puts. The way they work is that a put struck at $50 can't be assigned unless the stock is below $40, in which case they will cash settle for the difference between $50 and whatever price below $40 that the common is trading for.

I would imagine that this buffer means the premium taken in for selling them would be less than selling a similar exchange listed put.

The term reverse convertible is defined in the article as "structured products offered by major banks to investors who are looking for high levels of income." It is not clear to me whether this will look similar to PUT (low probability) or look much different due to cherry picking only the most volatile stocks but it will be interesting to see if it turns out to be less volatile than I think (the 20% buffer could be a difference maker).

The strategy of selling puts is just fine most of the time especially in a market that is up a little or down a little. During up a lot the strategy lags the market and, depending on the particulars of a down a lot market, the strategy can be ruinous, like being forced to buy something like Ariba (NASDAQ:ARBA) nine years ago for $250 while it was trading at $40 on the way to single digits. The nature of the PUT index has been much different, of course, but anyone with the vaguest interest in a fund like this needs to understand the worst consequence of the strategy.

PBP has $148 million in it, which seems decent to me, so I am not sure why they have not offered an ETF that tracks PUT. The potential utility of these sorts of things, but of course they need to prove themselves, would be as bond fund substitutes should interest rates rise in a meaningful way. A situation where short term rates went to 6% and longer term rates were at 9% would blow up a lot of bond funds and hurt a lot of people.