In a sideways trending stock market, investors may do well with a buy-write strategy, capitalizing on the attractive yield generation.
After a multi-year bull run, the S&P 500 may be winding down. Goldman Sachs even stated that “flat is the new up,” telling clients that the market will not do much through the end of 2015, reports Julie Verhage for Bloomberg.
Goldman Sachs points to a number of factors that will keep the equities market in a sideways range. For starters, Goldman calculates that the S&P 500 is trading at fair value. Overall company earning growth will remain flat for the year. Some investors are already throwing in the towel, with domestic equity ETFs and mutual funds experiencing outflows while international funds are seeing greater inflows. Lastly, the Goldman team pointed to modest economic growth, forecasting GDP growth of 2.6% in the second half.
Looking ahead, Goldman Sachs projects a 12-month target for the S&P 500 of 2,150, or 3% above current levels and expects the index to rise to 2,300 in 2017.
“An economic contraction is decidedly NOT in our forecast,” according to Goldman Sachs. “Investors point to the 18% collapse in Brent during the past six weeks, the weak macro data from China and the spillover effect on global demand growth, lingering uncertainty in Europe, and the 25 bp compression in 10-year US Treasury yields during the last 30 days (to 2.19%) as reasons for concern about a US downturn. Our response is that, while the current US expansion is long in temporal terms (6 years), the magnitude of the recovery is weak and on that basis the expansion phase is closer to early-/mid-cycle.”
Consequently, in a flat market, ETF investors may turn to the buy-write, or covered call, strategy to capitalize on yield generation. For instance, investors can take a look at the Powershares S&P 500 BuyWrite Portfolio (NYSEArca: PBP), the largest buywrite ETF based off the S&P 500, and the Horizons S&P 500 Covered Call ETF (NYSEArca: HSPX), which also employs a covered call strategy on the S&P 500. PBP has a 3.3% 12-month yield and HSPX has a 3.3% 12-month yield [Covered Call ETF Generates Income, New Highs]
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.
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. Consequently, during the easy-money fueled stock market rally, the buy-write strategy has underperformed the S&P 500. [Buy-Write ETF Strategy for Better Risk-Adjusted Returns]
For more information on the covered call strategy, visit our buywrite category.
Max Chen contributed to this article.