Rising interest rates served the predictable end of boosting bond yields, but that also means 2022 will go down as one of the worst years on record for the bond market because when yields rise, prices slide.
Even with unusually high yields throughout the fixed income space, the case is growing for investors to consider alternative income sources. Those include buy-write, or options selling strategies, which offer investors not only robust income streams but reduced sensitivity to rising interest rates, too.
“No two buy-write strategies are the same, but they tend to have some strong commonalities. A buy-write strategy will typically hold (“buy”) a diversified basket of stocks to mimic a particular index — the S&P 500, for instance — and sell (“write”) related call options seeking to generate additional income from the premium. In short, a buy-write strategy forfeits potential equity upside in exchange for enhanced income above and beyond equity dividends,” according to Goldman Sachs Asset Management (GSAM).
Indeed, some retail investors are familiar with covered calls on single stocks – selling call options on a stock the investor holds to boost income. However, employing that strategy in broad-based form is capital- and labor-intensive – traits that highlight the utility of buy-write strategies in fund form.
Today, there are dozens of buy-write exchange traded funds for investors to consider. These products include active and passive fare and, in many cases, are linked to familiar equity benchmarks such as the S&P 500 and the Nasdaq-100 Index (NDX). Generally speaking, these funds are at their best in sideways markets, but in volatile markets, investors may be willing to exchange upside potential for reduced volatility and elevated income.
“For instance, considering rolling one-year returns (measured quarterly, over 20 years), the CBOE S&P 500 2% OTM Buy-Write Index — a reasonable proxy for the Buy-Write strategy universe in aggregate — has outperformed the S&P 500 more than 50% of the time in flat markets, but nearly three-quarters of the time in negative return periods. In negative return markets, the CBOE S&P 500 2% OTM Buy-Write Index outperformed the S&P 500 by an average of 370 bps. Often, playing good defense can be a solid foundation for long-term outperformance,” added GSAM.
These days, buy-write strategies can not only elevate investors’ income streams but provide the lower drawdowns essential to long-term portfolio health.
“A smoother glide path may be more likely to keep investors engaged with their investment programs—and with equities — to the benefit of their long-term financial health. In an era of rising costs and eroding purchasing power, we think that’s engagement worth having,” concluded GSAM.
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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.
