Using ETF Covered Calls To Soften Sell-off

April 15, 2014

Covered-call options can make volatile markets less scary, according to one RIA.

The S&P 500 Index has been retreating in recent weeks, thanks to a sell-off in momentum stocks, as investors continue to digest escalating tensions between Russia and Ukraine escalate, coupled with weak economic data out of China.

But covered-call strategies using ETFs can be a great way to offset losses and even stay in the black, according to Kevin Simpson, president and chief investment officer of Naples, Fla.-based Capital Wealth Planning.

Simpson told that his firm was able to keep many portfolios in the black in the first quarter using its own custom-made covered-call strategies. But he also said that even covered-call strategies packaged in stand-alone ETF wrappers are a relatively safe way to buffer returns in volatile markets. So how did your portfolio fare during the last quarter?

Kevin Simpson: Our covered-call ETF portfolio posted a positive return in the first quarter. Typically, our covered-call overlay benefits from sector sell-offs that have a tendency to pull down the broad market. For Q1, the momentum that came out of specific tech names and small- and midcap biotech names likely helped our covered-call overlay.

Our overlays generally benefit from broad market sell-offs a bit more than single-sector sell-offs, but we certainly benefit from pullbacks and volatility more so than we do a straight-up market, like the one we saw in 2013. And we expect to be able to sell a few more covered calls more effectively than we were able to last year, if volatility continues to enter the market. Can you give us a breakdown of your portfolio?

Simpson: We have a 10 percent allocation to the ProShares Short S&P 500 ETF (SH). We have some sector exposure in consumer staples [the Consumer Staples Select Sector SPDR Fund (XLP | A-91)], health care [the Health Care Select Sector SPDR Fund (XLV | A-92)], and we just made a small allocation to gold [the SPDR Gold Trust (GLD | A-100)], which we haven’t owned in the portfolio since 2011. When did your firm begin to roll out the covered-call strategy, and why?

Simpson: Capital Wealth Planning was started in 2005, and we really started building ETF portfolios around the end of 2007. We have $400 million under management.

The covered-call strategy is interesting in that it is an ETF-based product. We only purchase exchange-traded funds.

We sell out-of-the-money covered calls—[when the strike price is above the current trading price of the underlying security]—from the exchange-traded funds that we own in the portfolio.

When ProShares came out with its inverse exchange-traded funds, it allowed us to implement the downside protection we needed. But it wasn’t until around 2007 where there was enough liquidity around that ETF [SH] where we could sell covered calls on the inverse position.


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