Time For Buy-Write ETFs?

by: Zacks Funds

The year 2016 saw an appalling start on the bourses as last year's headwinds spilled over this year with deepening woes. This is especially true as the world's second-largest economy is not showing any sign of reviving anytime soon and the global oil market continues to be overloaded. These two issues have been thwarting global economic growth and raising threats of deflation (read: 5 ETF Plays for a Bear Market).

In fact, both the World Bank and International Monetary Fund (IMF) downgraded their projection for world economic growth. The World Bank cut its growth forecast to 2.9% for this year from 3.3%, while IMF expects the global economy to grow 3.4% this year, down 0.2% from its previous estimate. Moreover, IMF warned that the global economy is on the verge of another financial meltdown. The World Bank stated that persistent weakness in China and a worse-than-expected slowdown in Brazil and Russia have worsened an already bleak global economic outlook.

Further, on the domestic front, weak Q4 corporate earnings, a strong dollar, uncertain timing on the next interest rates hike and a spate of weak economic data are weighing heavily on investors' sentiments. In particular, the U.S. economy grew at a slower pace of 0.7% in the fourth quarter after having advanced 2% in the third quarter and 3.9% in the second. With this, the rate of economic expansion in 2015 is the same as that of 2.4% in 2014.

In such a sluggish backdrop, investors are looking to provide capital appreciation opportunities in the equity world with simultaneous downside protection. 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 same 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 products would probably underperform in bull markets, as this strategy eats away the potential gain especially in a short time frame. However, investors seeking to make a play on the broad U.S. equity indices using this strategy could consider the following ETFs (read: 6 Quality Dividend ETFs for Safety and Income):

PowerShares S&P 500 BuyWrite Portfolio ETF (NYSEARCA:PBP)

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 $314.6 million in AUM and trades in average daily volume of nearly 180,000 shares a day. The product is a bit pricier than the other choices, charging 75 bps in annual fees. The ETF has an annual yield of 2.34% and has shed 5.8% so far this year.

Horizons S&P 500 Covered Call ETF (NYSEARCA:HSPX)

This ETF seeks to match the performance of the S&P 500 Stock Covered Call Index, which holds a long position in the stocks of the S&P 500 Index while at the same time, short (write) call options on option-eligible stocks in the S&P 500 Index. The fund has accumulated $57 million in its asset base and charges 65 bps in fees per year from investors. Volume is light as it exchanges less than 5,000 shares in hand on average daily basis. The ETF has 5.43% in annual dividends and has lost 7.7% in the year-to-date timeframe (read: Buy-Ranked Large Cap Value ETFs in Focus).

Recon Capital NASDAQ 100 Covered Call ETF (NASDAQ:QYLD)

This ETF follows the CBOE NASDAQ-100 BuyWrite 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 $30.2 million in AUM and trades in light volume of under 18,000 shares a day on average. Expense ratio came in at 0.60% and annual dividend yield is higher at 10.45%. QYLD has lost 9.7% so far this year.

AdvisorShares STAR Global Buy-Write ETF (NYSEARCA:VEGA)

This fund is actively managed and looks to provide investors with consistent, repeatable returns across all types of market environments. This may be done by using a proprietary strategy known as Volatility Enhanced Global Appreciation. VEGA is primarily a fund of funds and employs a Buy-Write or Covered Call overlay for its global allocation strategy using ETPs. The ETF has amassed $20.5 million in its asset base, while trades in average daily volumes of 4,000 shares. It charges a higher fee of 2.15% a year from investors and is down 5.7% in the same time period.

iPath CBOE S&P 500 BuyWrite Index ETN (NYSEARCA:BWV)

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 $9 million and average volume of under 1,000 shares. The ETN charges 0.75% in fees and expenses and has lost 6.9% in the year-to-date timeframe.

Bottom Line

Though these products have delivered negative returns from a year-to-date look, yields are impressive, making up for most of the losses incurred so far. As such, these are appropriate for investors seeking high levels of current income and a hedged exposure to the large cap U.S. equities. It is worth noting that the funds will lag significantly during a boom time, but will be an interesting choice in flat or declining markets, especially for investors seeking extra income in a volatile environment.

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