The Buy/Write ETN as a Substitute for SPY -- Less Volatility, But Where's the Growth?

Roger Nusbaum submits: I have been wondering whether this new BuyWrite ETN (BWV) could serve as substitute for a regular S&P 500 fund when combined with one or two other products.

The idea would be to capture most of the effect with less volatility. My first thought is some sort of combo of BWV and iShares DJ Dividend Select Fund (DVY), which a few clients own.

If SPY yields 1.5%, a 50/50 mix of DVY (3% yield) and BWV (no actual payout) obviously means no yield is given up.

The thing that is given up is growth. You may have a negative opinion about growth, but no growth makes for an undiversified portfolio. If you want to add growth, how much should you add? It appears that growth accounts for 48% of the S&P 500. I get 48% by looking at the Total Market Cap numbers for the S&P 500 Growth and S&P 500 Value ETFs, iShares S&P 500 Growth (IVW) and iShares S&P 500 Value Index ETF (IVE) respectively.

Since this is just theoretical, I could see where 25% to growth, 35% to DVY and 40% to BWV could create the effect -- but it would be very underweight growth. Because BWV is brand new, there is no way (at least I'm not aware of away) to analyze this as a portfolio. See the chart (below) though, and you will see that during dips of varying magnitude in the last two-and-a-half-years the BXM index (the thing that BWV will try to mimic) has really held up very well, which is why I have waited a product like BWV to come along.

Lest anyone add one plus one and get eleven, I still believe it makes sense to let BWV prove it can track the BXM index. While I don't know exactly how long it will take to prove itself, I would think it would take at least several months.

This post belies the fact that I am favorably disposed but I have no position, and I can't be certain at this point if I ever will have a position.

Comments

[Michael Bom...:]

Hey Roger,
From what I can tell, the Dow Writer DPD is good to look at too. It seems to have better correlation (cross) to underlying volatility, which is an additional benefit over just an index tracker.

2007 May 31 01:15 PM

[Tristan Yates:]

Interesting article. I think buy/write is a lot more popular in the flat to down markets. I remember reading some studies about how buy/write funds were able to outperform the index in 2001 and 2002, but then lagged in 2003 and later years. A buy-write fund is actually both long and short the index simultaneously and has some weird "delta-neutral" characteristics. You're never quite sure what its going to do when the index goes up or down.

2007 May 31 02:32 PM

[Michael Bom...:]

Markets like this last month make delta seem irrelevant, I'd worry more about gamma and rho characteristics at least for the next couple months.

2007 May 31 02:40 PM

[Roger Nusbaum:]

my allocation to the strategy is modest and more intended to to effect the entire portfolio.

2007 May 31 10:18 PM