Options-Based ETFs Generate Better Risk-Adjusted Returns | ETF Trends

Exchange traded funds that employ options have performed as well as the S&P 500 Index with lower volatility, providing investors with higher risk-adjusted returns.

“Options-Based Funds had similar returns as the S&P 500 Index with lower volatility and lower maximum drawdowns. The Options-Based Funds had higher risk-adjusted returns, as measured by the Sharpe Ratio, Sortino Ratio and Stutzer Index,” according to a recent white paper commissioned by the Chicago Board Options Exchange, titled Performance Analysis of Options-Based Equity Mutual Funds, CEFs and ETFs.

The white paper analyzed 80 Options-Based Funds focused on U.S. equities, including ETFs like the Powershares S&P 500 BuyWrite Portfolio (NYSEArca: PBP), the largest covered-call ETF based off the S&P 500; the Horizons S&P 500 Covered Call ETF (NYSEArca: HSPX), which also employs a covered call strategy on the S&P 500; the First Trust High Income ETF (NasdaqGM: FTHI), which writes covered call options on the S&P 500; the First Trust Low Beta Income ETF (NasdaqGM: FTLB), which buys put options on the S&P 500 and writes covered call options on the same index; the Recon Capital NASDAQ-100 Covered Call ETF (NasdaqGM: QYLD), which provides a covered-call strategy that targets Nasdaq-100 securities; and the ALPS U.S, Equity High Volatility Put Write Fund (NYSEArca: HVPW), which sells two-month 15% out-of-the-money put options on 20 diversified stocks with the highest implied volatility.

The covered-call options strategy allows an investor to hold a long position in an asset while simultaneously writing, or selling, call options on the same asset. Traders would typically employ a covered-call strategy when they have a neutral view of the markets over the short-term and just bank on income generation from the option premium. [ETF Chart of the Day: Call Coverage]

In a flat market condition, the trader would use the buy-write strategy to generate a premium on the option. If shares fall, the option expires worthless and one still keeps the premiums on the options. However, the strategy can cap the upside of a potential rally – the trader keeps the premium generated but any gains beyond the strike price will not be realized.

Selling puts can reward investors in a stagnant or rising stock market as the trader would collect premiums, or yields, if the strike price remains below the current market price of a security.

From 1988 through the end of 2014, both the CBOE S&P 500 PutWrite Index and CBOE S&P 500 2% OTM BuyWrite Index generated higher returns and lower volatility than the S&P 500 Index, according to the white paper. The strong risk-adjusted returns are attributed to the richly priced options.