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File this under "News to Me" (as I'm not sure if this stuff is common knowledge in the options community)

I just found out that there are ETFs that use an option index approach. The idea is that you buy the S&P 500 and then sell covered calls. Here are two sites that talk about it (granted, they're trying to sell the index).

http://www.cboe.com/micro/bxm/Callan_CBOE.pdf

http://www.cboe.com/micro/bxm/introduction.aspx

According to the data, you get the same (or better) performance with 2/3 the volatility. Interesing idea... Even if you disreguard the MPT idea that a big component of risk is volatility, portfolio volatility is a drag on performance.

I could only find two ETFs that track these indexes, BEP and BEO. Both trade at a premium to NAV, but that can change quickly. The big problem with them is the 1% expense ratio. When I did some math a while back about the effects of volatility on portfolio performance, it seemed that the overall risk was about 1.5% on a standard "agressive" MPT alloaction if you held the end point constant (ie, start with X and end with Y modulate volatility of returns and compare required annualized performance). That was based on Bernstein's Intelligent Asset Allocation, but I might be misinterpreting.

In any case, I'm posting here because I'm curious to know what you think of the approach? Is it worth the expense ratio? Has it been debunked by the community or is it yet to catch on?

My own take is that it is not worth the expense (as it would provide only a 0.4% advantage over a Vanguard ETF before taxes), but if there were lower cost vehicle out there it could be compelling. A do it yourself approach is not possible, as SPY trades for around $145 a share and would allow for appropriate diversification of writes.

Thanks,

Dave
Who is still reading McMillan
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I just found out that there are ETFs that use an option index approach. The idea is that you buy the S&P 500 and then sell covered calls.

So why not just sell the puts instead, and just have the one transaction?
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I guess the point in buying the stock and then selling covered calls is that by going long on the stock, you're at least guaranteed the market return. By selling covered calls, they'll hopefully beat the market by the amount of commissions made by selling the covered calls.

Paul
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But you aren't guaranteed the market return by holding the ETF if you sell the covered call on it. The covered call limits your upside return. And if you write it far enough OTM to reduce that risk, your premium will be lower as well.

My problem with a covered call strategy is that in order for it to make you more profit then just holding the underlying equity, then just the selling of the calls has to be profitable. But:

-- If you can't consistently make profits just selling the calls, why bother selling any of them?

-- If you can sell calls and be consistently profitable with them, why bother buying the underlying equity?

Keep in mind that the losses on a sell calls only strategy is the very same profits you are willing to throw away on the equity when you sell the covered calls. They can't be significant on one hand and insignificant on the other.
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