ETF Expert

Volatility in stocks making you antsy once again? Wondering if you should pull an itchy trigger finger and sell?

In truth, cash is going to make its way back into stocks, bonds commodities, currencies… anything… as long as borrowing costs are so low. So you can expect dip-buying on pullbacks, corrections and dips for 6-9 more months.

However, if the roller-coaster ride has you tied in knots, there are ways to minimize the angst. For instance, there are a number of “Buy-Write” ETFs that use a covered call or, buy-write, strategy. A Buy-Write ETF tracks an established stock index (i.e. the “buying” part), while simultaneously selling call options (i.e. the “writing” part) on the same stocks to collect an option income stream.

A few years ago, PowerShares introduced its PowerShares S&P Buy-Write Portfolio (PBP) to employ just such a ”covered call” approach. And it has indeed been less volatile than the S&P 500 SPDR Trust (SPY).

By design, PBP would make less on the upside because outside investors would have the option of calling away stock positions in a strong uptrend. Yet, PBP would lose less on the downside because one is collecting an option income stream even though outside investors decline to “call away” stocks that are worth less.

It’s said that the “buy-write” approach works best in flat markets… or those that are only slightly higher or lower. This is because you’d be picking up your option income stream like a rent check, and you’d still have the basket of stocks. In a collapsing market, however, when you’ve lost 1/3 or more of your money, it’s little consolation to say that you’re down -33% to the S&P 500’s -42%. Stop-loss selling for protection is much better!

Yet there’s little denying the appeal of this approach on days of uncertainty. The PowerShares S&P Buy-Write Portfolio (PBP) normally trades 50,000 shares daily. On the 3rd consecutive day of selling pressure… on 11/20/2009… 200,000+ shares traded.

Still, I have some concerns about a fund like PBP. With net assets of just $120M… and with average daily trading in the range of just $100,000… the bid/ask risk is quite high. In PBP’s case, it is typically 0.5%… or a round-trip cost of 1.0% to buy and sell.

In addition, the PowerShares S&P Buy-Write Portfolio (PBP) isn’t a way to generate more income in the form of monthly or annualized yield; most of the option income is reinvested. In effect, PBP is a stock fund for buying and holding where it’ll lose a little less at the expense of gaining a little less.

However, what if you like the “buy-write” concept, but you actually want to pocket more of the income stream? Since PBP’s inception in late December of 2007, it has lost -16.6%. However, the Eaton Vance Tax-Managed Global Buy-Write Fund (ETW) has gained 3.3%. Also, ETW has a current annual dividend yield of 12% after expenses… 3% delivered quarterly.

If you’d like to learn more about ETF investing… then tune into “In the Money With Gary Gordon.” You can listen to the show “LIVE”, via podcast or on your iPod.

Tags | "covered call ETF", "covered calls ETF", "etf buy-write", "etf covered call", "etf covered calls"