Why You Should Avoid Closed-End Fund IPOs -- Hard Data

by: Abnormal Returns

It has often been said that you should never buy a closed-end fund upon its initial public offering. Gregg Greenberg at TheStreet.com illustrates that aphorism well. 2005 has been a bad year for buyers of these, too often, me-too funds:

Of the 45 IPOs released since January, only four as of the beginning of this month are trading above their offering price, and 24 are down 10% or more.

Some of this underperformance may be due to the large number of funds that are dependent on option writing for their performance. Kopin Tan in Barron’s wrote on the rise of this class of option writers putting downward pressure on implied volatilities.

Once upon a time, option volume was more directly hitched to stock-market volatility, with investors rushing to trade puts and calls when underlying shares gyrate. But for the third straight year, option volume has soared in 2005 even as volatility declined or stayed low — an indication, at the very least, that trading is driven not just by expectation of stock movement, but by hedging and the selling of options to drum up income. That impression is corroborated by closed-end funds using call-selling strategies that have raised more than $18 billion in the past 16 months — a trend that shows no signs of abating in 2006.

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