Writing Covered Calls With ETFs

January 25, 2017

How do you feel about ETFs that package a covered-call strategy, like the PowerShares S&P 500 BuyWrite Portfolio (PBP)? Have you ever used those?
No; but we’re huge supporters and proponents of them. Much like the low-beta ETFs, we wouldn’t necessarily want to use a covered-call ETF, because we’re already writing covered calls as a function of the portfolio. There’s a redundancy factor, if we included them. So they probably wouldn’t be candidates for us. But we’re rooting for them, for sure.

How do you go about evaluating liquidity?
What’s more important [than liquidity in the options] is the liquidity of the ETF itself. It’s certainly important that there’s liquidity and good open interest in the option chain, because we wouldn’t want to write calls on an ETF that didn’t have a robust option chain—not for this portfolio. Ultimately, though, we want to find ETFs where we can have good option chains and tight spreads, good open interest, good volume and so on.

Are there particular asset classes or sectors you exclude?
We’re selective in terms of what ETFs we won’t own. We don’t want things that are leveraged, as we talked about. We also try to stay away from ETFs with contango or that have some kind of derivative component to them. We want funds to be as transparent and simple as possible. Again, that’s not a criticism of other products; it’s just that, with our model, we want to keep it simple.

Looking ahead to 2017, what are your expectations for the market, and how has that affected your overall strategy, if at all?
Since the financial crisis, quantitative easing has kept rates artificially low. We’ve also seen volatility staying historically low—I’m not suggesting that’s a direct result of quantitative easing and lower rates, but it certainly has an effect on volatility. A rising stock market with very low volatility—that’s affected the premium we generate on covered-call writing. With our ETFs, specifically our index-based ETFs, it’s been harder to write option premiums or find option premiums that have sustenance.

But we’ve seen volatility beginning to increase a little at the end of 2016. We’d expect that, as interest rates normalize over time, volatility could also normalize over time, and it should benefit our covered-call premiums, because higher volatility means higher income.

It’s not really a question of us doing anything different; we do the same thing every month, whether volatility is high or low. But certainly higher volatility will allow us to generate greater premiums in our covered calls. So we wait with anticipation for volatility. We like when there’s volatility in the market.

 

 

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