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Covered Calls Finish Strong in 2011

Tue, Jan 3, 2:41 PM ET, by Bill Luby

Just looking back at The Year in VIX and Volatility (2011) is enough to make one's stomach churn. Try to tell someone who has acrophobia that even the scariest roller coaster ride ends up right where it started and you will likely not assuage any fears. Something similar is at work for hikers, bikers or mountain climbers. The amount of effort they will need to call upon has nothing to do with ending up at the same elevation they started, but rather it is the cumulative elevation gain over the course of the trail, road or mountain. As with many things in life, it is all about the journey, not the destination.

For those who may have a touch of acrophobia, prefer their hikes to put less stress on their cardiovascular system and want a portfolio that matches the way they wish to experience the world, covered calls or buy-write strategies might be the answer. I have addressed the subject of covered calls and buy-writes a number of times in the past on this blog (see links below), but essentially this is a strategy which sells calls against an existing (covered call) or new (buy-write) long position in order to generate income off of the underlying. Covered calls and buy-writes will generally beat the SPX/SPY if stocks decline, move sideways or rise slowly. The cost to implementing one of these strategies is that if the markets make a sharp bullish move, gains are capped by the covered calls.

In the ETP world, there are two choices when it comes to buy-write strategies:

  • PowerShares S&P 500 BuyWrite Portfolio ETF (PBP)
  • iPath CBOE S&P 500 BuyWrite Index ETN (BWV)

PBP is by far the more liquid of the two alternatives, but some investors may also have reason to prefer BWV's approach and performance.

In the chart below, I have captured the equity curve of PBP vs. SPY over the course of the second half of 2011 - a period in which stocks generally moved sideways and volatility remained high. In other words, a period that was tailor-made for buy-write strategies. Note that PBP outperformed SPY by 7.7% during this six-month period, with considerably less volatility and also a less peak-to-trough drawdown"¦or what alpinists would probably call cumulative elevation loss.

Should high volatility persist in 2012 and stocks end up near where they started the year, both PBP and BWV are likely to outperform the major market indices.

Related posts:

 


[source(s): ETFreplay.com]


Disclosure(s): long PBP at time of writing; TradeKing is an advertiser on VIX and More



SDI Glossary: "Call" Definition
SDI Glossary: "CBOE" Definition
SDI Glossary: "Option" Definition
SDI Glossary: "VIX" Definition
This Article's Word Cloud:   BuyWrite   Calls   Covered   Index   Markets   More   Sideways   TradeKing   Volatility   Year   acrophobia   also   below   call   calls   course   covered   cumulative   elevation   generally   have   high   less   likely   long   make   markets   mountain   move   over   period   prefer   sideways   started   stocks   strategies   that   their   these   they   this   volatility   want   where   which   will   with   world   write   writes

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