Tag Archives: pro

Do Covered Call ETFs Deserve A Look?

Covered Call ETFs (or Buy-Write ETFs as they’re known to some) are an intriguing option for investors looking to generate a little extra portfolio income. But you have to have some sense of where the market is heading in order to really profit from them. Covered Call ETFs are generally known for their high yields. One of the largest covered call ETFs – the PowerShares S&P 500 BuyWrite Portfolio (NYSEARCA: PBP ) – sports a trailing 12 month dividend yield of just over 4%. That number is actually low in the covered call ETF universe as smaller funds like the Recon Capital NASDAQ 100 Covered Call ETF (NASDAQ: QYLD ) offer yields in the 8-9% range. Here’s how they work. In a typical equity ETF the fund’s managers buy individual stocks and hold them within the portfolio. In a covered call ETF, managers take the same stock positions but simultaneously write call options on those positions (thus the name “buy-write”). The goal is to benefit from the equity position while at the same time generating an income on the side. While the yields are nice, the overall performance of the buy-write ETF really depends on the direction of the market. In up markets, buy-write ETFs tend to underperform as the written calls start getting exercised limiting an individual stock’s upside potential. Conversely, these funds tend to outperform in sideways or down markets as many of the written calls expire worthless leaving the fund to simply collect the option premiums. The PowerShares S&P 500 BuyWrite Portfolio has historically performed about as would be expected. It outperformed the S&P 500 during the time right after the financial crisis as stock prices were dropping and subsequently lagged the index for much of the last four years. However, the fund has returned roughly 5% year-to-date outpacing the S&P 500’s return of almost 2%. If global economic weakness would be expected to continue, covered call ETFs could begin outperforming again.

Investing Opportunities As Central Banks Diverge

Stocks rallied last week as investors looked past the tragic attacks in Paris and once again focused on central bank policy. In particular, investors celebrated the potential for more central bank divergence: tightening by the Federal Reserve (Fed), while the European Central Bank (ECB) pursues easing. In the U.S., investors now appear to be treating a December Fed rate hike as a sign of economic stability rather than as something to be feared. As such, investors were cheered last week by the October Fed meeting minutes , which implied that the central bank views the economy as strong enough to justify an initial rate hike, most likely in December. Meanwhile, European stocks continued to rally on hopes of more monetary stimulus, rather than signs of economic recovery. Investors got what they were looking for last week, with several ECB officials confirming the likelihood that the central bank will expand its quantitative easing (QE) program. As I wrote in my latest weekly commentary ” Cheering, Not Fearing, a Rate Hike? “, as these central banks diverge, there are several implications for investor positioning. Consider overweighting hedged European equities. A falling euro and an ECB likely to expand its monetary stimulus are both catalysts for Europ ean stocks . The one caveat: Given that further gains are partly predicated on a weaker currency, dollar-based investors should continue to consider currency-hedged vehicles . In the U.S., consider adopting a modest tilt toward large- and mega-cap stocks. At first blush, my preference for U.S. large-cap stocks seems counterintuitive, given expectations for a stronger dollar. Generally, a strong dollar is seen as more of a headwind for large caps, which have a greater exposure to international sales. However, this year has demonstrated how the relationship is more complex. Yes, a stronger dollar has proved a headwind for large-cap company earnings, but small caps have actually been underperforming, according to Bloomberg data. Part of the reason has to do with why the dollar is appreciating: rising real (after-inflation) interest rates. As data accessible via Bloomberg show, U.S. real 10-year rates are up roughly 60 basis points (0.6 percent) since the end of January. This, in turn, is having an impact on small-cap valuations, based on Bloomberg data. Through October, S&P 500 Index multiples actually rose a bit. However, the price-to-earnings ratio on the Russell 2000 Index of small-cap stocks contracted by around 2.5 percent. It should be noted that this is consistent with history. Looking forward, to the extent we see a gradual rise in real rates, higher real rates are likely to keep small-cap valuations under pressure. Finally, according to Bloomberg data, large- and mega-cap names also have the advantage of cheaper valuations relative to the broader market. This post originally appeared on the BlackRock Blog.

From The Studs Up: Building (And Rebuilding) A Portfolio With MPT

An optimal investment portfolio contains assets intended to show well in the light and in the dark. That means it’s built to suit for your risk tolerance and target time frame, for moments of market clarity and uncertainty. We’re talking about modern portfolio theory (MPT), which aims to optimize potential returns for nearly any given risk. Modern portfolio theory has a fresh-sounding resonance, but it’s a 63-year-old investing model structured on three elements: asset allocation, diversification, and periodic rebalancing . At its roots, MPT is a basic investing model – and by now a fundamental one – that embraces diversification and equilibrium while sticking to a measured regime of the classic buy low/sell high. “The idea is that by sticking to that kind of discipline, you can ride out the down markets by staying diversified, and not making rash moves when the market is going up significantly or pulling back,” says John Bell, director of guidance platforms and tools at TD Ameritrade. For example, asset classes whose prices go sharply higher tend to become overweighted and could warp the balance. “If you’re consistently rebalancing back to a target, in general you will be selling the assets that are most highly valued and overpriced, and buying those things that are undervalued and underpriced,” Bell adds. “Buy low/sell high is what rebalancing allows you to do without attempting to introduce biases into your analysis. The beauty of calendar-based rebalancing is there’s nothing more magical about it other than enforcing some discipline,” he says. Mix of Materials Modern portfolio theory was first penned in 1952 by economist and Nobel Prize laureate Harry Markowitz, who used mathematics to support his theory that you can minimize risk and maximize returns by holding a combination of asset classes that aren’t correlated to each other and that align with your personal appetite for risk as well as your age . In other words, with MPT, you spread the risk among assets that don’t typically behave in the same way. It all boils down to these three components: Asset allocation. Investment products span asset classes that might include stocks, bonds, cash, real estate, international holdings, and emerging markets. Ideally (although this isn’t always the case), each asset class performs differently over time and has different levels of risk. For instance, equities typically have higher risk than fixed-income products, but the return is generally greater over time. Diversification. MPT disciples choose assets that don’t correlate to each other, like oil and food, or technology and apparel, domestic versus foreign, large cap versus small cap, and so on. Rebalancing. Consider regular realignment of a portfolio to the target asset allocation already in place. Certain stocks in your portfolio, for example, might soar and upend your targets. Rebalancing allows you to get back on task and, MPT proponents argue, tends to lower the portfolio’s risk. Check Emotions at the Door Why such lasting power for MPT? Because self-control practiced through rebalancing manages two emotions that typically prompt investors to make bad decisions: greed and fear. “Human behavior sometimes trumps logic and sound thinking,” Bell says. “People tend to buy at the absolute worst time and sell at the absolute worst time. Discipline takes the human emotion part out.” But MPT is not bullet-proof. It’s aimed at helping you dodge what’s called “undiversifiable” risk, or what happens when you have all your investment eggs in one asset-class basket and that class stumbles. If all your money was tied up in stocks in 2008, you likely lost a big chunk of change. Wealth Accumulation MPT also follows a basic school of thought about accumulating and keeping wealth. In your 20s, when you have decades of investing before you, conventional wisdom urges taking more risks, perhaps investing more heavily in equities than fixed income in your portfolio weightings. The assumption is that you have time to recover from a harrowing market event that could wipe out 50% of your portfolio. Remember 2008? But if you’re in your 60s, when time has snuck up on you, MPT says it’s best to protect your wealth by taking a more conservative approach without swaying too far from your goals. Those who ran for the hills and converted equities to cash in 2008 probably missed the bull market that followed. MPT cannot – and does not claim to – eliminate “systematic” risk, or what happens when the entire market takes a tumble. But it can soften the blow. Rather than suffering a 50% loss along with the stock-market crash of 2008, a well-balanced portfolio may have set you back only 25% or sometimes less. “You’ll very rarely ever be at the top or the bottom of a broad group of asset classes, but most likely in the middle. That makes sense, because you have a mix of all the asset classes,” Bell says. Disclaimer: TD Ameritrade, Inc., member FINRA/SIPC. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. Commentary provided for educational purposes only. Past performance is no guarantee of future results or investment success. Options involve risks and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before investing.