The Way KraneShares Uses Volatility to Generate Income

It all starts with the firm’s flagship ETF, the KraneShares CSI China Internet ETF (KWEB B). The fund is designed to capture the growth opportunity in China. The concentrated thematic China ETF has a 10-year track record — and it’s volatile.

So, when KraneShares started studying the covered call space, the firm decided to create something that was the counterpart to KWEB.

“We’ve always had what I would describe the ultimate growth strategy for China. But one of the things that kept coming up was ‘well how do you monetize the volatility that is China?’” KraneShares COO Jonathan Shelon said during VettaFi’s Income Strategy Symposium on October 27.

If KWEB is the growth bookend, the firm wanted to offer an income bookend, he noted.

In response, the firm created a pure-play alternative income strategy. The solution, the KraneShares China Internet and Covered Call Strategy ETF (KLIP ), invests directly in KWEB and writes at-the-money calls over a tenor of 30 to 40 days to maximize the option income opportunity.

KLIP pays its earnings to investors monthly. Impressively, the alternative income strategy has paid out an average of 4.5% per month to investors over the last nine months.

“That is the level of option income that we generate every month because the underlying basket is so volatile,” Shelon explained. “There’s a very clear relationship between the amount of volatility that the underlying investment has and the amount of income that you can generate.”

Currently, volatility is slightly elevated compared to the historical average. KWEB’s historical implied volatility is in the low 30s. Right now, however, implied volatility is in the high 30s, according to Shelon.

“This income relationship pairs up with volatility, which means that we’re paying in the 4% to 5% range this year,” he said.

It’s important to emphasize that the income that KLIP generates depends on the level of volatility. If volatility goes down, KLIP’s option income could also decrease.

However, even in a lower volatility environment, KLIP has the potential to generate attractive income for investors.

“If we approach historic averages for KWEB implied volatility, we’ll be paying in the 3% to 4% range,” Shelon said. “What’s unique about this is if volatility picks up; in other words, if things happen that increase volatility, our income potential rises.”

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