Posted on 06/30/2011
With the fourth of July just around the corner, it is quite clear we are now in the heart of the summer. Most people will probably be taking vacations, spending time at the beach, and most likely doing some leisurely reading through the latest financial periodicals. That said, whether you are nearing retirement or you are an income-oriented investor, you serve as a captive audience for articles tailored to finding income generating opportunities, whether it be through some structured product, individual bonds, or dividend related funds. It’s a topic of concern nowadays especially as the “baby boomer” generation retires, as well as the fact that we continue to find ourselves in a low interest rate environment. In fact, if you look at the U.S. 5-year Treasury Yields (FVX), they have not been above 4% since October 2007, above 3% since October 2008, and more recently slipped beneath 2% at the end of April of this year. All of this serves as supporting evidence for why it’s important to find a strategy that provides sufficient income for investors who require it, but also a strategy that is capable of adapting to changing conditions within the global marketplace.
While there are various ways to generate income for a portfolio, today we wanted to discuss covered/buy write exchange traded products as they are used as a means to increase additional income. As of now 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). Both the BWV and PBP are employing similar investment strategies; they track the CBOE S&P 500 BuyWrite Index by employing the “buy write” methodology, primarily within the S&P 500 Universe. "Buy Writing" is an options strategy used to generate income, and consists of writing call options on an underlying stock. Ordinarily, the PBP will concentrate at least 80% of its total assets on these 500 stocks, and according to Powershares, subsequently "sells one-month at-the-money S&P 500 Index call options against the portfolio." Dividends from the underlying stocks of PBP are reinvested into the fund, which currently distributes a yield of 1.439%.
The "Buy Write" strategy does provide income for investors, but the return is often capped to the upside, especially in a bullish market when the price of the underlying stock moves above the option's strike price. For instance, in 2008 the S&P 500 (SPX) fell -38.49%, yet the PBP only fell -30.62%. During the rally in 2009, PBP was able to participate, and thus produced a return of 21.87%, underperforming the SPX, which was up 23.45%. But the purpose of PBP is to provide investors exposure to a strategy that offers income, which is why it makes for a unique position in an income generating "core satellite" portfolio. If you would like more information on PBP, click here, and for more information on BWV, click here.