Equities benchmarks have hit record highs, with the Dow Jones Industrial Average recently breaking above 20,000 for the first time, as we head toward the ninth year of the bull market rally. Investors who are skeptical about how much further we can go from here can look to exchange traded funds that track buy-write or covered call strategies to generate attractive yields if markets slowdown in the year ahead.
Market valuations have continued to push higher, and many traders are waiting on corporate earnings to validate the high prices on many stocks after the recent President Donald Trump-induced rally helped push benchmarks to records. However, after a multi-year rally, investors should not expect stocks to continue strengthening at the breakneck speeds of yesteryear.
Moreover, most of the recent strength in the equities rally was due to the so-called Trump bump as traders fueled price gains on expectations that president Trump will enact expansionary policies, like tax cuts, deregulation and increased fiscal spending. The new administration, though, has not provided a lot of details on these promises, and some investors have kept expectations in check.
Consequently, with the stock market rally growing long in the tooth, investors should turn to alternative investments like a buy-write or covered calls that could be an effective investment strategy in a more sideways trending market, which allow us to capture some upside while generating income through the option premium.
There are a few covered call or buy-write ETF options available. For instance, the Powershares S&P 500 BuyWrite Portfolio (NYSEArca: PBP) is the largest buy-write ETF based off the S&P 500, and the Horizons S&P 500 Covered Call ETF (NYSEArca: HSPX) also employs a covered call strategy on the S&P 500. The iPath CBOE S&P 500 BuyWrite ETN (NYSEArca: BWV) utilizes covered calls on the S&P 500 but it comes in an exchange traded note wrapper.
The Recon Capital NASDAQ-100 Covered Call ETF (NasdaqGM: QYLD) provides a covered-call strategy that targets Nasdaq-100 securities.
The actively managed AdvisorShares STAR Global Buy-Write ETF (NYSEArca: VEGA) employs a covered call strategy through global stocks ETFs, including emerging markets and developed EAFE countries, along with some international bond exposure.
Lastly, the recently launched actively managed Amplify YieldShares CWP Dividend & Option Income ETF (BATS: DIVO) also employs an existing strategy managed by Capital Wealth Planning that is made up of mega cap, high quality, blue chip stocks designed to deliver income through selling short-term covered calls against 30% to 60% of underlying holdings to generate additional income.
Covered-call options allow 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 gather income from the option premium. While these buy-write ETFs may not produce any phenomenal price returns compared to the broader equities markets, their underlying option strategy helped them generate outsized yields.
For instance, HSPX gained 19.4% over the past year while the S&P 500 rose 23.3%. However, HSPX has also generated 3.24% 12-month yield, compared to the S&P 500’s dividend yield of just over 2.0%
If the markets stay within range or trade in a more sideways fashion, investors 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, potential investors should keep in mind that the strategy can cap the upside of a continued rally. The trader keeps the premium generated but any gains beyond the strike price will not be realized. Consequently, in a stock market rally, the buy-write strategy has underperformed the equities market.