AdvisorShares, one of the largest issuers of active ETFs, continues to cultivate new relationships and fill the product pipeline with ideas for new exchange-traded products. Earlier this month the company filed details on a fund that would combine a common and long-standing investment strategy with the exchange-traded structure, shedding some light on plans to launch the STAR Global Buy-Write ETF (VEGA). The proposed ETF would be sub-advised by Partnervest Advisory Services.
AdvisorShares has taken a unique approach to development of its active ETFs; the company has partnered with a number of different sub-advisors to allow asset management firms to deliver their strategies in the ETF wrapper.
The “buy-write” strategy is relatively straightforward, and has been implemented by investors for years. This technique essentially involves combining a long position in equities with a short position in call options on those equities–buying the stocks, while simultaneously writing call options on them. The premiums generated from the writing of call options provides an opportunity to enhance income to the portfolio, while the long position in equities limits the exposure that would be incurred by simply writing the options.
Buy-write strategies generally perform well in flat markets, since the income earned through the collection of option premiums enhances bottom line returns. When the stocks held rally, the gains to this strategy are limited as a result of the obligations incurred related to the call options (which become “in-the-money” to the holders when the underlying securities appreciate). Buy-write strategies also can be appealing when markets slump, since the premiums collected on options that expire worthless dampen the losses incurred by the long position in stocks.
According to the filing, the proposed ETF would rely on a quant-based methodology to select both the equity securities and derivatives positions. The filing also noted that the fund managers would have the ability to establish “principal protection” to hedge against potential price declines of 20% or more. That protection would be achieved through the purchase of put options on the equity positions held by the fund.
If approved, VEGA won’t be the first exchange-traded product to offer investors exposure to the buy-write strategy; there are currently two index-based ETFs in this corner of the market. Existing buy-write ETPs include:
- PowerShares S&P 500 BuyWrite Portfolio (PBP): This ETF is linked to the CBOE S&P 500 BuyWrite Index, which combines a long position in the S&P 500 index and the sale of a succession of one-month, at- or slightly out-of-the-money S&P 500 Index call options that are listed on the Chicago Board Options Exchange.
- iPath CBOE S&P 500 BuyWrite Index ETN (BWV): This product is linked to the same index as PBP, but is structured as an ETN. That means that investors in BWV are exposed to the credit risk of the issuing institution, but will avoid tracking error that can arise from the execution of the sale of call options.
A head-to-head comparison of PBP and SPY highlights the risks and opportunities of this strategy. The buy-write ETF exhibits significantly lower volatility than traditional long only exposure to the S&P 500, but has lagged behind the SPDR in recent sessions as equity values have climbed sharply higher.
Disclosure: No positions at time of writing.
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