Smallcaps for the Risk Averse

Feb. 4.08 | About: Small Cap (RCC)

After years of outperformance versus large-caps, smallcaps finally disappointed last year. The Russell 2000 ETF (NYSEARCA:IWM) peaked at about $85 in July, then tumbled inexorably for the rest of the year as convulsions in global credit markets spawned by the U.S. residential mortgage bust shattered collective investor complacency. And when emerging markets began cratering as the new year commenced, smallcaps plunged into bear market territory and "decoupling" decoupled from the bull train.

After bottoming on January 22 at $64.19, however, the IWM has since ascended to $72.63, boosted by the Fed's heavy lifting. If you're eager to get back into the Russell 2000 but fear the murky depths below, consider the Small Cap Premium & Dividend Income closed-end fund (RCC), which essentially duplicates the Russell 2000 but then trades potential upside for downside protection by selling covered call options on the Russell 2000 index. The fund pays a biannual dividend of $1 and is likely to continue to do so as volatility in the markets drive option premiums higher. At $15.81 per share, which is a discount to the $16.22 NAV and not far from the 52 week low of $15.28, the current dividend distribution rate equals 12.65%. If we in fact reached the bottom on January 22 and the stock continues to recover (the 52 week high was $21.18), the total return could easily top 20%. If, on the other hand, markets retest the January lows or fall even further, the dividend will support the stock and you'll get paid handsomely to wait. For the tempted but timorous with a moderately long investment time horizon, the RCC is just too compelling to ignore.

Disclosure: Author has a long position in RCC