Indeed, these are turbulent times for equity markets. High inflation, rising interest rates, and a five-week skid for the S&P 500 are among the factors confirming as much.
With stocks slumping and interest rates rising, income investors may feel at a loss for ideas. After all, rising rates are punishing bonds, and sliding equity prices make it difficult to embrace dividend equities, no matter how defensive.
Fortunately, there are income-generating alternatives, including the WisdomTree CBOE S&P 500 PutWrite Strategy Fund (NYSEArca: PUTW). PUTW follows the CBOE S&P 500 PutWrite Index (PUT Index), which writes at-the-money put options every month. Translation: PUTW is an options selling/writing strategy.
“You can think of a put option as an insurance contract. The writer plays the part of the insurer, who charges the owner a premium to ensure the price of their underlying asset if it falls below the strike price agreed upon in the contract,” notes Alejandro Saltiel, WisdomTree research director. “The options sold by the PUT Index use the S&P 500 Index (S&P 500) as the underlying asset. At-the-money means the strike price agreed to on these contracts is equal to the current price of the S&P 500.”
Options-writing exchange traded funds, including PUTW, are designed to generate income from the sold options. In theory, volatile market settings, such as the current one, should be beneficial to these funds because increasing volatility often prompts higher options premiums.
The primary risk facing PUTW investors is that if the S&P 500 drops below the strike price of the ETF’s sold puts, “the PUT Index is required to pay the difference between the strike price and the current level of the S&P 500. This difference can be more or less than the premium initially collected,” adds Saltiel.
PUTW’s upside is capped, and its downside is essentially the S&P 500’s monthly downside, if any. Some of the premium PUTW collects can defray some of the potential downside.
Bottom line: PUTW is a fund built for volatile markets. The fact that it has a double-digit performance advantage over the S&P 500 this year proves as much.
“For example, during the first quarter of 2022, the strategy behind the PUT Index collected premiums totaling 7.58% as volatility spiked. During this quarter those premiums mitigated market drawdowns and the PUT Index returned 1.72%, while the S&P 500 Index had a return of −4.60%,” concludes WisdomTree’s Saltiel.
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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.