Investors can utilize a put-write exchange traded fund strategy to generate attractive returns in a slightly downward trending or sideways market.
Put writing has been used by many market participants for decades as a way to potentially increase the yield and smooth out the ride of equity returns over various market cycles.
Put options allow a buyer the right, but not the obligation, to sell a specific quantity of a security at a set strike price, or exercise price, on or before an agreed expiration date. The put option buyer would pay the seller a premium for this right to sell. The put write strategy would generate income through these premiums.
Selling puts can reward investors in a stagnant stock market as the trader would collect premiums, or yields, if the strike price remains below the current market price of a security. Traditionally, investors would benefit from the the put write strategy during sideways trending markets as people just pocket the premiums or income generated. Additionally, the strategy may outperform the S&P 500 when the market is declining, but it can underperform when the market is rising.
Potential investors, though, should keep in mind that in a strong bear market, the put-write strategy may be exposed, especially for related ETFs. During periods of high volatility of underlying securities, more puts will have a higher probability of expiring in the money or being exercised early.
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On the other hand, the put-write strategy can be a good way for income-minded investors to increase their portfolio yields, especially in a low and rising rate environment that has sideways trending or bull market conditions. The high volatility of the underlying securities should benefit since the put-write strategy can benefit on inflated option premiums while taking advantage of fewer put payouts.
Potential investors who are interested in the put-write options strategy can take a look at the WisdomTree CBOE S&P 500 PutWrite Strategy Fund (NYSEArca: PUTW). The WisdomTree PutWrite ETF tries to reflect the performance of the CBOE S&P 500 PutWrite Index, which implements a put write strategy on the S&P 500 Index. PUTW includes one- and three-month Treasury bills and sells or “writes” one-month, at-the-money, S&P 500 Index puts. Investors can use PUTW “to help lower portfolio beta and reduce downside risk,” according to WisdomTree.
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.