With a stellar end to the month for stocks, the spike in volatility seen last month may be on its way to becoming a distant memory for some investors.
What should not be a distant memory are the exchange traded funds that provided investors with legitimate durability when volatility surged. After all, equity investors need to realize that the last two years of sanguine market environments and muted volatility are rare occurrances.
“Since 2012, investors have enjoyed an nearly unprecedented run-up in equity prices accompanied by extremely low historical volatility,” according to Horizons ETFs.
Horizons sponsors the Horizons S&P 500 Covered Call ETF (NYSEArca: HSPX), the covered call equivalent of a basic S&P 500 index ETF and one of the few equity ETFs that proved legitimately durable when volatility jumped last month.
As Horizons notes, “rising prices and low-volatility have not favored covered call-writing or other defensive equity strategies. October might have signaled a change to more normalized market conditions, accompanied by volatility that is more representative of the long term average.”
While there has been a historically noticeable inversion correlation between equity prices and volatility, rising volatility is not always a guarantee that stock prices will erode. That highlights the importance of realizing that covered call strategies, such as HSPX, are long equity strategies.
HSPX’s underlying index utilizes an “out-of-the-money” covered call strategy. The out-of-the-money call option will take a strike price higher than the current market price of the underlying security. While the performance of HSPX, and those of its rivals, has lagged the S&P 500 during the bull market last year, covered call ETFs can prove durable in range-bound or down-trending markets. [Covered Call ETF Hits New Highs]
The covered call strategy is a good way to generate cash in a muted market environment. By implementing a covered call strategy, an investor who owns a stock sells, or “writes,” call options and collects the income from the premiums paid by the buyer of the option.
HSPX also has credibility as an ETF for income investors. Last month’s spike in volatility juiced options yields, enabling HSPX to pay a dividend of 25 cents per share. That work’s out to be 6.65% on an annualized distribution yield basis. HSPX also pays its dividend monthly, not quarterly. [ETFs for Monthly Dividends]