by Aaron Levitt | March 19, 2013 2:51 pm
Given that the Fed’s zero-interest-rate policies aren’t going away anytime soon, many investors have turned toward the “exotic” to find yield. From convertible bonds to master limited partnerships, Wall Street has gone headstrong into these niches to produce new exchange-traded products for portfolios craving income.
And the latest ETF could be a doozy.
The ALPS US Equity High Volatility Put Write ETF (NYSE:HVPW) combines stocks and an options strategy, exploiting quick-darting equities in the hope of generating 1.5% in distributions … every 60 days.
While that might seem like a spam advertisement for penny-stock gains, the fund strategy seems sound, albeit risky.
By using options, investors can generate income, provide downside protection or produce exaggerated returns in rising markets.
However, for many investors, options strategies remain an elusive tactic. After all, concepts like spreads, collars and buy-write aren’t exactly commonplace or well-known with the average Joe. They can be confusing to execute properly or take large initial investments, making them out of reach for many portfolios.
Thus, it might pay to hire a professional … or at least track an index.
The first ETF products in the space — such as the PowerShares S&P 500 Buy Write (NYSE:PBP) — were designed to track basic options strategies like selling covered calls. By taking a relatively sophisticated tool and placing it in an ETF, more retail investors have the opportunity to use it in their portfolios.
Well, the new ALPS US Equity High Volatility Put Write ETF takes that sophistication up a few notches.
HVPW will track a portfolio of written put options on the largest-capitalized stocks that have listed options with the highest volatility.
Puts are a type of option that are used to provide the owner the right — but not the obligation — to sell the security at a set or “strike” price, on or before an expiration date. Traders who sell put options have essentially sold the right to another investor to sell shares at an agreed-upon price. On the other hand, the buyer has the purchased the chance to sell stock to the put writer.
Selling — or “writing” — puts is a strategy that succeeds when the underlying stock stays flat or goes up. However, it can be very costly if the stock plummets, as the put writer could be forced to purchase shares of a stock at $100, when it has actually fallen to $50.
In return for providing this insurance — by essentially putting a price floor under a stock by writing the option — HVPW will collect a juicy fee.
HVPW will “write” 60-day listed put options on 20 different stocks, selling the right to buy them at roughly 85% of their price at the time. Basically, the fund is on the hook for the difference below a roughly 15% drop in price.
The ETF has chosen to focus on the companies with the highest volatility, as fast-moving stocks often have the largest premiums when it comes to option writing. This makes sense as the option’s strike price is more likely to be breached with a stock that swings wildly in price compared with a boring name whose share price rarely moves.
The fund holds exclusively T-bills — used as collateral — with top current put options written on biotech Alexion Pharmaceuticals (NASDAQ:ALXN), social media travel site TripAdvisor (NASDAQ:TRIP) and Chesapeake Energy (NYSE:CHK). The rest of the holdings are a virtual who’s who of momo names and traders’ delights, offering plenty of volatility and high option premiums.
The fund hopes to collect those outsized insurance premiums as they expire every 60 days and distribute 1.5% to investors after expenses. That works out to be a huge 9% dividend yield — if HVPW is successful at delivering its put-write strategy over the course of the year. A big deterrent could be those expenses, which run at a high 0.95%. Still, that’s pretty cheap considering how expensive and time-consuming HVPW’s strategy would be to undertake on your own.
The ALPS US Equity High Volatility Put Write ETF is an interesting alternative way to gain some hefty yield in a portfolio. Not many investors use put options to their advantage and the fund has basically democratized the strategy for the masses. Overall, the ETF should do well when markets are trending higher or sideways and provide some big distributions to investors.
However, it isn’t without its risks. HVPW could underperform in strong rallies and selloffs. That means the fund shouldn’t be the only source of yield in your portfolio. Think of it as a satellite play or yield-booster.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.
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