New “BuyWrite ETF” Hits The Market

by on September 18, 2012 | ETFs Mentioned:

AdvisorShares added another actively-managed ETF to its lineup this week, rolling out a fund that employs a “covered call” overlay to a global asset allocation strategy. The new STAR Global Buy-Write ETF (VEGA) will hold a portfolio of exchange-traded products while simultaneously writing call options against each position. VEGA also has the flexibility to use protective put options in low volatility environments to manage downside risk.  

VEGA will be subadvised by Partnervest Advisory Services; James Herrell and Kenneth Hyman will be the portfolio managers. 

Covered Call 101

Covered call strategies offer an opportunity to lower overall volatility and generate streams of current income in certain environments. This strategy combines traditional long positions (e.g. holding the S&P 500) with a short position in call options on those same assets. Writing call options allows the portfolio to generate additional income, as it will take in the premium on the options at the time of writing. If the underlying asset declines in value, the options will likely expire worthless–thereby bolstering the performance of the portfolio, which is able to keep the proceeds generated from writing the call options. 

Of course, if the call options end up having substantial value the portfolio will be on the hook to the holders of those options. So when the underlying long positions appreciate, a covered call strategy will generally lag behind traditional long only assets.  

Covered Call ETFs

VEGA joins a few other covered call or buy-write ETFs already on the market that implement similar strategies, though this fund is the first to utilize an active strategy. Both of the existing buy-write ETPs are linked to the S&P 500: 

  • PowerShares S&P 500 BuyWrite Portfolio (PBP): This ETF implements a covered call strategy on the S&P 500, holding the stocks that make up the large cap index while also writing call options on that index.   
  • iPath CBOE S&P 500 BuyWrite ETN (BWV): This note offers substantially identical exposure, except that it is structured as an ETN as opposed to an ETF. That means that investors are exposed to credit risk, but won’t experience tracking error related to either the stock or option component of the strategy.  

A comparison of the performances and volatility of PBP and SPY illustrates the features of a covered call strategy. With markets generally climbing this year, PBP has lagged behind a “plain vanilla” S&P 500 ETF such as SPY–in this case, by a fairly wide margin. The covered call ETF, however, exhibits considerably lower volatility than SPY, even in bull markets.   

Disclosure: No positions at time of writing.