Posted on 09/16/2011
We've discussed on more than one occasion the spike in volatility throughout the course of the last several weeks. As a result of the August correction, followed by range bound trading action and more than a fair share of news stories to increase market uncertainty, many investors have moved their assets towards more conservative strategies by implementing various hedged approaches. Some of those include investing in inverse ETFs (single beta or leveraged), volatility ETFs, covered write ETFs, or a combination of those to provide them with downside protection, but still the potential to gain from an anticipated upside movement of some sort in the future.
While inverse and volatility exchange-traded products perform well in a weak market environment, covered write ETFs do not necessary follow the same pattern. As a matter of fact, a covered write strategy is designed for investors who are looking for income generating opportunities. Currently there are two products that provide buy-write exposure; the iPath CBOE S&P 500 BuyWrite Index ETN (BWV) and the PowerShares S&P 500 BuyWrite Fund (PBP). They both track the S&P 500 BuyWrite index by employing the "buy write" methodology, which is an options strategy used to generate income by writing call options on an underlying stock.
Another ETF that can be used as a hedging mechanism, although it doesn't fall into one of the aforementioned classifications, is the RBS Trendpilot Large Cap US ETF (TRND). The ETN operates a little differently than most exchange-traded products as it doesn't simply follow the index in a passive manner. At the end of the close of each day, the S&P 500 Total Return index is compared to its 200-day moving average. If the index closes below the 200-day MA for five consecutive trading days, then the TRND automatically moves to 100% invested in three-month treasury bills. However, if the index closes above the 200-day MA for five consecutive trading days, then the TRND switche back to a full investment in the index.
To give you an idea of how these various products have performed over the past 10 years, we have put together a performance quilt, which also includes a short term bond ETF, single/double beta, and inverse ETFs to serve as a yard stick of measures. As shown below, the ultra long funds such as the SSO tend to perform the best when we have a bull market while single or double beta short funds like the SH and the SJF do just the exact opposite. However, the TRND,BWV, and PBP aren't as extreme as they provide investors some added protection feature.